## 1fsmea2026001-source-pdf ## Source details **Canonical URL:** [1fsmea2026001-source-pdf](https://www.imf.org/-/media/files/publications/cr/2026/english/1fsmea2026001-source-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2026/english/1fsmea2026001-source-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2026/english/1fsmea2026001-source-pdf.pdf.json) --- ### Real sector developments, recent performance, and outlook - Real GDP growth: - FY2024: 2.3 percent. - FY2025: 1.1 percent. - FY2026 (near-term projection): 0.7 percent. - Medium-term: temporary pickup in FY2027 and FY2028, then growth slows to 0.7 percent over the medium term (below pre-pandemic average of 1 percent). - Inflation: - Headline inflation FY2024: 5.4 percent. - FY2025 preliminary: 3.2 percent. - Headline inflation expected in 2026: 3.2 percent. - Medium-term inflation expected to pick up to 4.0 percent, then converge toward 2.0 percent in the long run. - External sector: - Current account surplus: 2022 = 16.5 percent of GDP; 2024 = 3.5 percent of GDP; 2025 = 3.8 percent of GDP. - Trade deficit narrowed to 40 percent of GDP in 2025. - Fishing fees accounted for 23 percent of total revenue in FY2024. - Monetary framework: - The US Dollar is legal tender; FSM is fully dollarized and has no central bank. ### Fiscal developments and medium-term projections - General government fiscal balances: - FY2022: surplus of 16.8 percent of GDP. - FY2023: deficit of 1.8 percent of GDP. - FY2024: surplus of 1.7 percent of GDP. - FY2025: surplus narrowed to 0.4 percent of GDP. - FY2026 (projection): general government fiscal surplus projected at 0.4 percent of GDP. - Key fiscal and macro projections (selected): - Nominal GDP (FY2023): US$443 million. - Population (FY2023): 94,654. - GDP per capita (FY2023): US$4,680. - Real GDP (annual percent change): FY2024 2.3; FY2025 1.1; FY2026 0.7; FY2027 1.1; FY2028 1.4; FY2029 1.0; FY2030 0.7. - Consumer prices (annual percent change): FY2024 5.4; FY2025 3.2; FY2026 3.2; FY2027 4.0; FY2028 1.7; FY2029 2.0; FY2030 2.0. - Revenue and grants (percent of GDP): FY2022 76.1; FY2023 61.3; FY2024 61.5; FY2025 60.6; FY2026 62.4; FY2027 66.6; FY2028 69.3; FY2029 69.2; FY2030 64.8. - Net lending/borrowing (percent of GDP): FY2022 16.8; FY2023 -1.8; FY2024 1.7; FY2025 0.4; FY2026 0.4; FY2027 -0.3; FY2028 -0.6; FY2029 -0.8; FY2030 -0.9. - Public debt (end of period, percent of GDP): FY2022 15.1; FY2023 12.8; FY2024 10.4; FY2025 8.9; FY2026 7.5; FY2027 7.3; FY2028 7.7; FY2029 8.4; FY2030 9.1. ### Trust funds, grants, and financing - COFA and grants: - COFA grants increased to USD 140 million annually (29 percent of GDP in FY2024), up from 19 percent of GDP in FY2023. - New COFA provides USD 2.8 billion in sector grants through 2043 (as noted in Annex I). - Trust funds (levels and rules): - FSM Trust Fund (FSMTF) balance in FY2025 = 115 percent of GDP (USD 577 million at end-FY2025). - Compact Trust Fund (CTF) balance in FY2025 = 395 percent of GDP. - Combined Compact Trust Fund + FSMTF balances (millions of USD): FY2022 298.1; FY2023 325.6; FY2024 412.9; FY2025 509.6; projections through FY2030 and FY2031 provided. - FSMTF withdrawal rules: annual withdrawals capped at the lesser of 5 percent of the average total Fund balance over the preceding five financial years or the balance of the B Account; withdrawals restricted until FY2030 under law. ### Debt sustainability, composition, and stress tests - Public debt stock (as of Sep-25 / end-FY2025): - Total public debt: 44.5 (million of U.S. dollars); 8.9 percent of GDP. - External debt: 40.29 million; 8.0 percent of GDP. - Domestic debt: 4.39 million; 0.9 percent of GDP. - Memorandum: SOE debt 1/ = 20.94 million; 4.2 percent of GDP. - Creditor composition: - As of end-FY2025 around 70 percent of public debt is owed to the ADB. - DSA findings and risk ratings: - Country Composite Indicator (CI) index: 1.76; CI rating: Weak. - Under the baseline, no breaches in external debt indicators through FY2046, but stress tests (notably a natural disaster shock) can lead to breaches later in projection horizon. - Risk of external debt distress: assessed at moderate. - Risk of overall debt distress: assessed at moderate. - Stress-test highlights: - Natural disaster customized test (one-off shock to debt-GDP in FY2027, large growth and exports shocks) can cause PV of external PPG debt-to-GDP and PV of external PPG debt-to-exports to breach thresholds starting in FY2039 and FY2038 respectively. - Under baseline projections, public sector debt-to-GDP rises from 8.9 percent in 2025 to 38.7 percent by FY2046 in the presented series. ### Key risks and downside scenarios - Risk profile: risks are tilted to the downside; extreme climate events and implementation risks dominate. - Specific quantified vulnerabilities: - A 10 percent shock to global oil prices could increase inflation, with a lag, by 0.7 percentage points. - Oil imports historically average about 7.8 percent of GDP; food imports average 19 percent of GDP. - Imported diesel accounts for over 85 percent of electricity generation. - Box 1 — Downside Scenario (qualitative): - Slower implementation of infrastructure projects amid intensifying climate change depresses growth, exacerbates emigration and skills shortages, reduces fishing revenues faster than envisaged, and worsens fiscal balances. - Drought and saltwater intrusion reduce domestic food production, increase import dependence, and raise public health expenditure. - Recommended responses: deepen collaboration to resolve project execution impediments, request technical support from development partners, prioritize domestic revenue mobilization and adaptation expenditure, and ease regulatory barriers to private sector participation. ### Scenario-based simulations (DIGNAD model) — calibrated scenarios and results - Scenario definitions (selected): - Baseline (Scenario 0): Public investment 2026–2030 = additional 0.9 percent of GDP in standard infrastructure and 0.1 percent of GDP in resilient infrastructure annually; financed by grants; reconstruction after a 2030 disaster financed through concessional debt. - Scenario 1 (Scale-Up with Concessional Borrowing): 0.9 percent standard + 1.1 percent resilient (2026–2030); financed by concessional borrowing. - Scenario 2 (Scale-Up with Grants): same investment profile as Scenario 1; financed by grants. - Scenario 3 (VAT Reform with Extra Resilient Investment): scale-up as Scenario 1; permanent resilient investment after 2030 at 1 percent of GDP; VAT reform starting in 2027 raises additional 1.5 percent of GDP (0.5 percent returned to households; 1 percent finances permanent resilient investment). - Scenario 4 (VAT & PIE Reform with Extra Resilient Investment): builds on Scenario 3 with Public Investment Efficiency (PIE) increased from 50.0 percent to 70.0 percent; all extra investment financed by VAT revenue. - Calibrated parameters (percent unless noted): - Grants to GDP ratio: 28.2. - Public domestic debt to GDP ratio: 1.0. - Public concessional debt to GDP ratio: 9.1. - Public external commercial debt to GDP ratio: 0.5. - Return to standard infrastructure: 25.0. - Return to climate-resilient infrastructure: 30.0. - Public standard infrastructure investment to GDP ratio: 11.0. - Depreciation rate of standard public infrastructure: 7.5. - Depreciation rate of resilient public infrastructure: 3.0. - Public investment efficiency: 50.0 (baseline). - Share of capital in tradable sector: 40.0. - Share of capital in non-tradable sector: 55.0. - Simulation findings (selected quantitative outcomes): - Scaling up resilient investment (Scenarios 1 and 2) reduces real GDP loss from the natural disaster from 6.1 percent to 2.9 percent. - VAT reform (Scenario 3) produces additional fiscal space; public debt-to-GDP ratio in 2040 is around 1.8 percentage points lower relative to Scenario 2 and follows a declining trajectory. - Scenario 3: persistent public investment yields real GDP and private investment about 1 percent above their 2025 levels ten years after the natural disaster. - Combined VAT + PIE reform (Scenario 4): real GDP growth and private investment rise to around 2 percent above initial levels in the long run; public debt-to-GDP ratio declines below its 2025 level; private consumption recovers to be above its initial level. - Policy implications from simulations: - Priority to scale up climate-resilient infrastructure despite higher upfront costs; embed climate-proofing in public projects. - Improve PIM to raise investment efficiency and implementation timelines. - Domestic revenue mobilization (notably VAT) can create predictable fiscal space for resilient investment and reduce reliance on grants. - Use concessional borrowing prudently for high-impact resilient infrastructure and post-disaster recovery while maximizing access to external climate finance. ### Fiscal policy priorities, public financial management, and tax reform - Public spending effectiveness and PIM recommendations: - Enhance capacity to plan and implement public spending, particularly at the state level. - Strengthen PIM: develop standard methodology for project appraisal and selection, upgrade PMO technical skills, create a standard project implementation manual, and strengthen consolidated oversight by DOFA. - Codify procedures in a government regulation on public investment management to ensure transparency and enforcement. - Tax reform design and revenue impact: - Proposed package includes a 10 percent VAT, replacement of GRT with an NPT, conversion of import duties to excises on certain goods, a USD5,000 tax-free threshold for WST, NPT at 25 percent, presumptive tax USD150 for very small firms, and 15 percent WHT on non-resident payments. - Estimated net revenue increase from the reform package: 1.5 percent of GDP. - VAT revenue estimates: 10 percent VAT → 7.4 percent of GDP; 12.5 percent VAT → 9.3 percent of GDP; 8 percent VAT → 5.9 percent of GDP. - With limited exemptions, impact on tax revenue collection estimated at 2.1 percent of GDP; net impact on government budget 1.5 percent of GDP (VAT applied to government purchases increases government expenditure). - Medium-term fiscal strategy and FSMTF guidance: - Balance preserving fiscal buffers with financing development and climate-adaptation needs. - Consider a commitment to an operational surplus (excluding capital grants); continue saving windfall revenues to preserve intergenerational equity. - Use a mix of domestic resource mobilization, concessional loans and trust fund withdrawals to finance capital expenditure shortfall; apply cost-benefit analysis when choosing the financing mix. - Consider a lower bound on FSMTF withdrawals and escape clauses for exceptional circumstances; grant states greater autonomy over sub-accounts to incentivize contributions. ### Financial sector development and reforms - Key financial sector facts: - Deposit base almost matches GDP; share of deposits channeled into domestic credit only 10 percent. - Loan-to-deposit ratio (percent): FY2020 13.2; FY2021 11.8; FY2022 12.8; FY2023 11.6; FY2024 11.2; FY2025 10.8. - Deposits (percent of GDP): FY2023 100.0; FY2024 92.0; FY2025 96.4; FY2026 94.3; FY2027 93.2; FY2028 92.1; FY2029 91.0; FY2030 89.9; FY2031 88.8. - Loans (percent of GDP): FY2023 11.6; FY2024 10.3; FY2025 10.4; FY2026 10.6; FY2027 10.8; FY2028 11.0; FY2029 11.2; FY2030 11.4; FY2031 11.6. - Financial soundness indicators (selected): - Regulatory capital to risk-weighted assets: Jun-21 40.6; Dec-21 37.2; Jun-22 38.1; Dec-22 38.5; Jun-23 37.4; Dec-23 38.9; Jun-24 43.9; Dec-24 42.1; Jun-25 44.6; Sep-25 43.3. - NPL to total gross loans: Jun-21 0.7; Dec-21 1.3; Jun-22 1.2; Dec-22 1.4; Jun-23 1.6; Dec-23 1.7; Jun-24 0.9; Dec-24 2.8; Jun-25 3.4; Sep-25 7.5. - Return on assets: Jun-21 0.6; Dec-21 0.7; Jun-22 0.9; Dec-22 3.3; Jun-23 3.0; Dec-23 3.4; Jun-24 3.1; Dec-24 3.0; Jun-25 2.6; Sep-25 2.6. - Policy recommendations for financial sector development (Annex VI): - Use the Secured Transactions Registry to foster STR‑backed lending for small businesses. - Leverage digital banking, broadband expansion, and RMS to build credit histories and enable data-driven credit evaluation. - Modernize tax administration toward VAT to improve data quality for credit-risk modeling. - Expand DFI training, integrate financial literacy into vocational programs, and create consent-based data-sharing protocols between tax authorities and lenders. - Bring credit unions and FSMDB under FSMBB supervision and consider agency banking models to reach remote areas. ### Structural reforms, private sector, labor, and migration - Structural bottlenecks: - Heavy regulatory burdens, fragmented state policies, land tenure constraints, limited access to long-term leaseholds, and weak institutions hinder private sector development. - Reform priorities: - Harmonize foreign investment laws across states, create opportunities for private participation in sectors served by SOEs, standardize business regulations, digitalize regulatory processes, and improve land administration (cadastral maps, digitized registries, standardized lease templates). - Labor and migration: - Private sector employment declined about 11 percent from 2010–2024; public sector is the largest employer. - LFPR (Population Census 2010): about 57 percent; Chuuk (2010) LFPR 53 percent; female-to-male LFPR ratio 73 percent. - FSM emigration rate: 39.2 percent. - Policy actions: improve education and vocational training, revitalize private sector, deepen diaspora engagement, and implement targeted active labor market programs; consider engaging a migration taskforce and multisectoral initiatives. - Diaspora engagement: - Recommendation: prioritize a diaspora engagement strategy, improve digital and financial infrastructure to support diaspora ties and investment. ### Climate, disaster resilience, and adaptation priorities - Climate vulnerability and costs: - Climate adaptation needs estimated at around 30 percent of 2024 GDP annually (Annex I) and elsewhere cited as one-third of GDP. - Climate change projected to reduce tuna catches by 13 percent, potentially lowering GDP by 4 percent. - Over sixty WWII-era shipwrecks pose oil-spill risks; extraction cost per wreck estimated at 2–7 percent of GDP. - Resilience priorities: - Improve climate and disaster-risk data systems and hazard maps. - Scale up renewable energy and energy efficiency to deliver on NDC 3.0 commitments. - Enhance early warning and detection systems. - Accelerate development of a National Building Code. - Strengthen public investment management and integrate climate considerations into PIM. - Disaster financing: - Disaster Assistance Emergency Fund under Compact III: annual contributions USD250,000 each from the US Government and FSM; threshold for withdrawals increased to USD250,000 under Compact III. - Policy actions: deploy contingency funds, strengthen fiscal buffers, finalize the National Adaptation Plan, and mobilize external grant financing. ### Data, statistical capacity, and operational recommendations - Data gaps and timelines: - Many macroeconomic series available only with substantial lags; most series available up to FY2023; audited FY2024 data expected in mid-2026. - Monetary statistics limited by absence of central bank; banking system balance sheet data adequate for surveillance. - Public sector financial audits delayed; authorities and new auditors are working through past fiscal years. - Capacity development needs: - Additional hands-on CD and resources for the Statistics Department to close External Sector Statistics and other gaps. - Integrate ASYCUDA, FMIS, and RMS into statistical compilation to automate data collection and reduce publication lags. - Publish the 2023 Population Census to inform policy and migration analysis. - Fund engagement priorities: - IMF engagement centered on surveillance and capacity development: improve timeliness of macroeconomic statistics; strengthen PFM and PIM (including climate integration); revenue mobilization support for VAT. ### Authorities’ views and implementation constraints - Authorities concur risks are tilted to the downside and that realized impacts may exceed staff estimates. - Implementation constraints emphasized: - Skills shortages, procurement challenges, stricter bonding requirements, high staff turnover, and limited state-level capacity have delayed project execution and led to large unspent capital grants. - States have preferred establishing their own trust funds rather than contributing to FSMTF, complicating fiscal federalism. - Authorities’ priorities: - Preserve fiscal buffers while addressing development and climate-resilience spending needs. - Strengthen PIM through technical assistance, support VAT and NPT reforms with outreach, and review FSMTF withdrawal rules to balance intergenerational equity and fiscal support. - Maintain broadly balanced budgets and prioritize COFA infrastructure grants to improve climate resilience. ### Selected concise policy recommendations (aggregated) - Fiscal and PFM: - Strengthen public investment management and DOFA oversight; implement an MTFF; codify PIM procedures in regulation. - Target wage-bill management: prefer regular periodic reviews and link salary adjustments to performance evaluations. - Preserve fiscal buffers and use trust funds prudently; consider controlled FSMTF withdrawals with clear escape clauses. - Revenue and tax reform: - Implement a well-designed VAT (10 percent proposed) and replace GRT with an NPT to raise net revenue by 1.5 percent of GDP; align revenue-sharing with expenditure responsibilities; provide targeted measures for vulnerable households. - Climate and disaster resilience: - Scale up resilient infrastructure, embed climate-proofing in projects, finalize the National Adaptation Plan, and strengthen disaster financing and early warning systems. - Financial sector and private sector: - Promote STR-backed lending, digital banking, VAT-enabled tax reporting to build credit histories, strengthen supervision (FSMBB), bring credit unions under oversight, and expand financial literacy and DFI programs. - Structural reforms and labor: - Harmonize investment laws across states, reform land and lease frameworks, streamline business regulations and digitalize processes, invest in vocational training, and deepen diaspora engagement. *Source: IMF staff report — Federated States of Micronesia, Extracted content from the supplied PDF content unit.* ### 1. Real Sector Developments ____________________________________________________________________ 21 ### 1. Real Sector Developments ### Context - FSM faces fragility driven by remoteness, dispersed population, high vulnerability to climate change and governance challenges (Country Engagement Strategy, Annex I). - Near universal access to basic services and improved digital connectivity have been achieved. - Service quality is affected by aging infrastructure and wide disparities, particularly in outer islands and for low-income households. - The Strategic Development Plan 2024-2043 (SDP) prioritizes private sector development with emphasis on tourism and fisheries. - Renewal of the Compact of Free Association with the US (COFA, 2024-2043) includes a significant step-up in grants, providing an opportunity to reset the economic trajectory if coupled with reforms. ### Recent developments — growth, inflation, and external/fiscal dynamics - Real GDP growth: - FY2024: 2.3 percent (supported by a jump in fishing output, public sector wage increase, high bank profitability, and removal of a ban on deploying foreign workers). - FY2025: 1.1 percent. - Inflation: - Headline inflation FY2024: 5.4 percent (driven by high import prices for food, fuel and the wage increase; high services inflation, particularly hotels and restaurants). - Preliminary data suggest inflation slowed to 3.2 percent in FY2025. - Fiscal balances (general government): - FY2022: surplus of 16.8 percent of GDP. - FY2023: deficit of 1.8 percent of GDP (as windfall CIT from foreign-sourced income normalized and spending rose). - FY2024: surplus of 1.7 percent of GDP (due to cuts in congressional projects and increase in grants under the new COFA). - FY2025: surplus narrowed to 0.4 percent of GDP (primarily due to a decrease in fishing fees). - Current account (CA) surplus: - 2022: 16.5 percent of GDP. - 2024: 3.5 percent of GDP. - 2025: 3.8 percent of GDP (trade deficit narrowed to 40 percent of GDP; higher income flows from CIT on foreign‑owned offshore entities more than offset decline in fishing fees). - Fishing fees accounted for 23 percent of total revenue in FY2024. - The US Dollar is legal tender in FSM and there is no central bank. ### Outlook and medium-term prospects - Near-term projection: - FY2026 real GDP growth: 0.7 percent (real income compression and higher import costs, particularly for the fuel‑intensive fishing sector; partly bolstered by gradual pickup in public investment funded by COFA). - Headline inflation expected: 3.2 percent in 2026 (reflecting gradual passthrough of higher oil prices due to the conflict in the Middle East). - General government fiscal surplus projected: 0.4 percent of GDP in FY2026 (driven by elevated state government spending and hence imports). - Current account surplus projected: 1.1 percent of GDP in FY2026. - Medium-term: - Temporary pickup in growth in FY2027 and FY2028 from higher grants from MFIs and spillovers from Yap airport expansion by the US Department of War (estimated to cost 80 percent of GDP). - Growth then slows to 0.7 percent over the medium term, below the pre-pandemic average of 1 percent. - Inflation is expected to pick up to 4.0 percent (reflecting lagged effect of elevated oil prices). - Sovereign trust funds provide buffers: FSM Trust Fund (FSMTF) balance in FY2025 = 115 percent of GDP; Compact Trust Fund (CTF) balance in FY2025 = 395 percent of GDP. - Structural constraints: persistent capacity constraints, sustained emigration causing labor shortages, impacts of climate change that intensify over time if reforms and resilient infrastructure investment do not advance. ### Risks and scenarios - Risks are tilted to the downside (Annex IV); extreme climate events are a significant downside risk that can destroy infrastructure, impair livelihoods, exacerbate food insecurity, and delay development as resources are diverted to response and reconstruction. - Conflict-driven oil price shocks: - A 10 percent shock to global oil prices could increase inflation, with a lag, by 0.7 percentage points. - Historically, oil imports average about 7.8 percent of GDP and food imports average 19 percent of GDP. - Imported diesel accounts for over 85 percent of electricity generation. - Box 1 — Downside Scenario: - Slower implementation of infrastructure projects amidst intensifying climate change depresses growth, exacerbating emigration and skills shortages. - Inadequate infrastructure impedes private sector activity, further undermining growth prospects. - Fishing revenues fall faster than envisaged; slower growth impairs tax collection and deteriorates the fiscal balance. - Drought and saltwater intrusion reduce domestic food production, increasing import dependence and public health expenditure. - Recommended responses in the downside scenario: deepen collaboration with stakeholders to resolve project execution impediments and request additional technical support from development partners; prioritize domestic revenue mobilization, adaptation expenditure, and ease regulatory barriers to private sector participation. ### Authorities’ views - Authorities concur that risks are tilted to the downside and that realized impacts may be larger than staff estimates. - They emphasize that skills shortages, procurement challenges, and stricter bonding requirements have delayed project execution and led to large unspent capital grants. - Authorities viewed the impact of the Yap airport project as modest given likely limited engagement of local contractors. - Noted substantial cleanup and containment costs from a recent oil spill, with strain on fiscal resources, coastal ecosystems and tourism; such incidents remain a risk given over sixty shipwrecks in Chuuk lagoon. ### Policy discussions — Fiscal policy priorities and constraints - COFA grants and fiscal stance: - COFA grants increased to USD 140 million (29 percent of GDP) annually, up from 19 percent of GDP in FY2023. - Public debt was 9 percent of GDP in FY2025. - Projected fiscal easing over the medium term is considered appropriate given FSM’s buffers and development and climate-adaptation needs, conditional on preserving fiscal buffers and strengthening policy frameworks. - Debt sustainability risks are assessed to be moderate (DSA). - Fiscal challenges identified: - Expenditure pressures: - 2025-2034 Infrastructure Development Plan (IDP) identifies USD 4 billion (794 percent of GDP) in the project pipeline, two thirds of which are unfunded. - High climate-change adaptation costs and expenditure to address legacy environmental risks will largely be borne by the public sector given an underdeveloped private sector. - Shortcomings in public investment management (PIM) and capacity constraints delay project implementation and weaken the link between investment and growth. - Contingent liability risks from state-owned enterprises (SOEs) and the social security fund. - Revenue pressures: - Declining tuna biomass due to climate change is expected to reduce fishing fees. - Support from MFIs shifted from grants to a mix of grants and concessional loans starting in 2025; the committed project pipeline means the level of grants will not decline until FY2030. - Fiscal federalism: - Since FY2024, a share of fishing fees has been transferred from the national government to the states. - The national government cancelled transfers to the FSMTF and reduced congressional projects by an estimated 1.3 percent of GDP over two years. - States have not contributed to the FSMTF, preferring to establish and contribute to their own trust funds. - The national government’s fiscal balance turned to a deficit while states’ fiscal surplus widened as they absorb additional revenue. - Recommendations to strengthen public spending effectiveness: - Enhance capacity to plan and implement public spending, particularly at the state level. - Strengthen public investment management (PIM) to prioritize projects using evidence-based approaches and ensure competitive procurement. - Develop a standard methodology for appraising and selecting investment projects, upgrade technical skills of Project Management Offices (PMO) with development partner support, develop a standard project implementation manual, and strengthen consolidated oversight of the public investment portfolio by the Department of Finance and Administration (DOFA). - Reflect updated procedures for project development, appraisal, management and oversight in a government regulation on public investment management to ensure transparency and enforcement. *Source: IMF staff report — Federated States of Micronesia, 1. Real Sector Developments.* ### 13. Public sector compensation policy should aim to recruit and retain skilled workers ### 13. Public sector compensation policy should aim to recruit and retain skilled workers ### Public sector compensation: findings and implications - A statutory freeze on annual salary increases for public sector employees was in place from 1997 to 2022. - Wages were increased in FY2023 for the national civil service and in FY2024 for states. - Even with unfilled vacancies, compensation spending is high compared to peers, especially after the recent wage increase. - The significant increase: - slowed attrition of public servants; - widened the public sector wage premium over the private sector; - added to inflationary pressure. - Regular periodic reviews of compensation policy are preferable to large, one-off wage increases. - Staff recommend cautious management of the wage bill, including targeting increases to critical positions. - The resumption of annual performance evaluation of employees is welcome; staff encourage linking future salary adjustments to these evaluations. ### State-owned enterprises (SOEs) and utilities: fiscal risks and policy measures - Risks are mainly concentrated in state utility corporations, though many SOEs are financially weak. - State governments provide budget transfers to utilities and, at times, cover their debt service obligations. - Policy recommendations: - Adopt cost-reflective pricing for utilities to improve financial performance and ensure resources for infrastructure maintenance and grid upgrades. - Target cost-of-living support to vulnerable households while moving utilities toward cost-recovery tariffs. - Increase renewable energy generation to potentially lower tariffs. - Condition future transfers and guarantees on the preparation and regular updating of statements of corporate intent specifying financial objectives, performance targets, and reporting obligations. - Examples of recent state support and contingent actions: - The state government provided USD 0.8 million to the Pohnpei Utilities Corporation (PUC) in FY2023; PUC is the beneficiary of state guarantees for ADB loans. - Following PUC’s past debt service shortfalls, the national government withheld approximately USD 0.6 million of Pohnpei state’s revenue share in FY2023 to meet these obligations. - The Yap State Government paid USD 0.8 million in FY2023 to cover the principal and interest of the ADB loan owed by the Yap State Public Service Corporation. - The FSM Social Security Administration receives annual transfers of at least USD 1 million from the national government to ensure long-term solvency; staff welcome the ongoing actuarial assessment. ### Tax reform: design, impacts, and implementation needs - Proposed reforms include: - Introducing a 10 percent value-added tax (VAT). - Replacing the gross revenue tax (BGRT) with a net profit tax (NPT). - Expected effects: - A VAT reduces the tax burden on capital goods and business inputs currently subject to sales taxes, supporting investment. - An NPT encourages risk taking because businesses do not pay taxes if they make a loss and losses can offset future tax liabilities—beneficial for start-ups. - The reforms would raise revenue by 1.5 percent of GDP. - Implementation considerations: - Revenue sharing agreements should consider public service responsibilities of each level of government. - Communicate how additional revenues will be used for public services and measures to alleviate burdens on vulnerable households to garner support. - Capacity development (CD) will be needed to support tax reform efforts, similar to other Pacific Island countries. ### Medium-term fiscal strategy, FSM Trust Fund, and financing development needs - Medium-term strategy objectives and principles: - Balance preserving fiscal buffers with financing development goals, including climate-change adaptation. - A potential commitment to an operational surplus (excluding capital grants). - Continue saving windfall revenues to preserve intergenerational equity and shield the economy from volatility. - Financing the capital expenditure shortfall: - Available grants are insufficient to finance required capital expenditure. - Part of the shortfall can be financed by a mix of domestic resource mobilization (¶15), concessional loans and trust fund withdrawals (¶17). - Additional development partner support is needed for the remainder. - Use cost-benefit analysis to guide the mix of loans and withdrawals and reflect spillovers from concessional loans (e.g., accompanying technical assistance and impact on debt sustainability). - FSMTF preservation and withdrawal rules: - The goal of preserving the value of the FSMTF in real terms is sound. - Under the law, annual withdrawals are capped at the lesser of 5 percent of the average total Fund balance over the preceding five financial years or the balance of the B Account, which holds accumulated investment earnings available for distribution. The law also states that withdrawals from FSMTF are restricted until FY2030. - Consider a lower bound on withdrawals based on projected long-term investment returns to ensure continued budget support during negative investment returns while the withdrawal cap limits drawdowns in strong return periods. - Escape clauses can specify circumstances where FSMTF withdrawals can exceed the cap or be used for operational expenses. - Within overarching safeguards, states should be given greater autonomy over their sub-accounts to encourage contributions into the FSMTF rather than establishing separate state-level trust funds, which increase fragmentation. ### Fiscal frameworks, concessional borrowing, and public financial management - Medium-term fiscal framework (MTFF): - An MTFF can help ensure annual budgets are consistent with the fiscal strategy. - The FSM is the only PIC without an MTFF or fiscal rules. - The budget manual outlines components of an MTFF (fiscal strategy, balanced budget rule, medium-term macroeconomic and expenditure projections, expenditure ceilings). - The COFA includes reporting requirements broadly aligned with MTFF elements. - Key priority: move from formal articulation to implementation, particularly for states with higher revenue. - Implementation requires capacity development support. - Restarting concessional borrowing: - Emphasis on entrenching a medium-term perspective to ensure loans can be serviced, particularly by states. - National and state agreement to utilize concessional loans is positive. - Mitigating repayment risks through: - DOFA approval of all state borrowing; - Limits on borrowing aligned with states’ repayment capacity; - Screening of project proposals to reduce misutilization risk; - Regular fiscal reporting and monitoring of state finances. - Need greater debt management capacity and reinstatement of regular publication of the debt bulletin. - Public financial management roadmap: - Achievements under the 2023-26 reform roadmap: implementation of ASYCUDA, the revenue management system (RMS), and partial rollout of FMIS. - A follow-up PFM roadmap could focus on strengthening public investment management and implementing MTFFs. - An update of the 2017 public expenditure and financial accountability assessment could inform the new roadmap. ### Authorities’ views on fiscal policies and reforms - Authorities broadly concurred with staff’s recommendations, noting capacity constraints on implementation. - They agreed on the need to strengthen public investment management through technical assistance. - They supported the proposed public sector wage policy, noting that repeal of the statutory freeze on step wage increases and resumption of annual performance evaluations would facilitate implementation. - Elements of an MTFF are in the budget manual, but limited capacity has hindered operationalization. - National Tax Reform Task Force completed consultations with all states; consensus on tax reforms is gradually emerging. States are supportive or neutral, but an amendment to the constitution for Yap state is needed before implementation can proceed. - Authorities emphasized the importance of outreach to the private sector and households on VAT and NPT benefits, drawing on experiences in Palau and the Republic of the Marshall Islands. - Authorities noted they have maintained a broadly balanced budget but recognize substantial development and climate-resilience spending needs; they will review trust fund withdrawal rules and aim for closer coordination between national and state governments on FSMTF sub-accounts. - COFA infrastructure grants will prioritize improving climate resilience. *Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1fsmea2026001-source-pdf.pdf* ### 31. Efforts to strengthen climate and disaster resilience should continue. Priorities include ### 31. Efforts to strengthen climate and disaster resilience should continue. Priorities include ### Climate and disaster resilience priorities - Improve data systems for climate and disaster‑risk information, including expanding the coverage of hazard maps. - Scale up renewable energy capacity and energy efficiency measures to deliver on NDC 3.0 commitments. - Enhance disaster preparedness by continuing to improve early warning and detection systems. - Accelerate development of a National Building Code to close regulatory gaps for climate‑resilient construction. - Disaster Assistance Emergency Fund arrangements: - Under Compact III arrangements, the annual contributions have been USD250,000 each from the US Government and FSM, an increase of USD50,000 from the previous arrangement. - Withdrawals above USD100,000 under Compact II required U.S. Chief of Mission concurrence; under Compact III, the threshold increased to USD250,000, giving FSM greater flexibility in accessing emergency funds. ### Authorities’ views on climate and disaster resilience (paragraph 32) - Authorities noted that substantial spending requirements and complex implementation demands of adaptation initiatives remain key policy constraints. - Onerous requirements associated with accessing climate financing continue to pose challenges; authorities welcomed recent efforts by the GCF to simplify its procedures. - High staff turnover continues to impede project implementation. - Authorities reported progress with the NAP, supported by upcoming national and state level consultations. - Preparation of a national drought policy is ongoing. - Technical capacity limitations—particularly around project selection and planning—and coordination challenges across state governments hinder timely and effective implementation of climate‑related investment projects. ### Structural reforms to invigorate the private sector (paragraphs 33–35) - Need for close coordination between stakeholders due to complex governance and fragmented state policies. - Reform priorities: - Update foreign investment laws to harmonize them across states, increase transparency and broaden sectors eligible for investment; currently a “traffic light” system is used and industry classifications vary across states. - Create opportunities for private sector participation in industries currently served by SOEs (e.g., renewable energy generation, ports and telecommunications). - Support long‑term leaseholds to enable productive use of land while protecting customary ownership rights by improving cadastral maps, digitizing land and lease registry, and providing standardized lease templates; ensure each state has land regulations to increase transparency and reduce delays in settling land disputes. - Streamline and standardize business regulations across states; digitalize regulatory processes (e.g., a single online business portal covering national and state requirements). - Addressing emigration and labor shortages (paragraph 34): - Emigration has exacerbated labor shortages, particularly in skilled trades and technical roles; limited suitable jobs, low wages and a high cost of living have contributed to emigration of better educated citizens, particularly youth. - Policy actions: improve quality of education including vocational training; revitalize the private sector to create better employment opportunities; deepen diaspora engagement through dedicated programs to foster ties and inward investments. - Authorities’ views on structural reforms (paragraph 35): - Authorities broadly agreed with recommended reforms and noted many elements are reflected in strategic plans. - Gaining traction with states is challenging; states view harmonization as ceding power and prefer to reflect their own priorities. - Discussions with states on streamlining regulatory requirements continue, particularly in strategic areas such as fishing and allied industries. - Authorities see creating high paying jobs as key to slowing emigration; a migration taskforce is conducting a survey to determine factors driving outward migration. ### Data issues and statistical capacity (paragraphs 36–38) - Current shortcomings: - Many macroeconomic data series are only available with a substantial time lag, though timeliness has recently improved, with most series now available up to FY2023. - Public sector financial audits—the basis for Government Financial Statistics—have been delayed; authorities and the new auditors are systematically working through past fiscal years, with audited FY2024 data expected in mid-2026. - Staff encourage authorities to publish the 2023 Population Census as it is a key input to policy formulation. - Monetary statistics: absence of a central bank precludes compilation of central bank balance sheet and reserve/base money data; banking system balance sheet data are available and adequate for surveillance. - Closing data gaps requires: - Additional hands‑on CD and resources for the Statistics Department to address gaps (e.g., External Sector Statistics) and reduce publication lags. - Development partner support to integrate new information management systems (ASYCUDA, FMIS, RMS) into the compilation process to automate data collection and support timely releases. - Authorities’ views on data (paragraph 38): - Authorities agree on the importance of timely data provision and appreciated prompt CD support by IMF and PFTAC. - Authorities acknowledged identified data gaps and that additional resources are needed to close these gaps and support succession planning. ### Staff appraisal — key findings and policy recommendations (paragraphs 39–46) - Macroeconomic outlook and constraints (paragraph 39): - Medium‑term prospects remain subdued. - Temporary rebound in FY2024 before slowing in FY2025. - Inflation gradually declined but remains elevated. - Medium‑term growth constrained by structural bottlenecks, intensifying threat of climate change and limited private sector participation. - Fiscal deficits envisaged over the medium term as concessional loans are used to support development goals. - External position is substantially stronger than implied by medium‑term fundamentals and desirable policies, reflecting weak investment activity and precautionary saving given volatile balance of payment flows. - Public investment management (paragraph 40): - Establish a standardized framework for evaluating and screening investment projects to strengthen prioritization and delivery. - Enhance capacity in PMOs, provide clearer implementation guidelines and stronger portfolio oversight by the DOFA. - Codify updated appraisal and oversight procedures in a public investment management regulation to enhance transparency and enforcement. - The 2025-2034 IDP is identified as a good first step in improving project screening. - Tax and revenue reform (paragraph 41): - A modernized tax system can foster private sector investments and strengthen revenue mobilization. - Proposed VAT and NPT would reduce distortions by easing the tax burden on business inputs and encouraging risk‑taking; they would also improve business record‑keeping with positive implications for access to credit. - Revenue‑sharing arrangements should be aligned with expenditure responsibilities across national and state governments. - Financing development and climate adaptation (paragraph 42): - Priority to finance development and climate‑adaptation needs while protecting fiscal buffers. - Save windfall revenues in the trust funds to safeguard intergenerational equity and reduce macroeconomic volatility. - Given development needs relative to currently available grants, a mix of domestic revenue mobilization, concessional borrowing and trust fund withdrawals is necessary. - Strengthen the FSMTF withdrawal framework through clearer rules, including a lower‑bound on withdrawals and well‑defined escape clauses, and grant states greater autonomy over sub‑accounts to enhance predictability of budget support and incentivize states to save. - Financial sector development (paragraph 43): - Strengthen SME financial capacity, expand digital banking to generate usable transaction data, and capitalize on tax reforms to improve availability of business financial information to ease credit constraints. - Continue efforts to enhance financial literacy, deepen institutional cooperation, and reinforce supervisory oversight to safeguard financial integrity and support prudent financial deepening. - Climate and disaster resilience (paragraph 44): - Focus on completing the National Adaptation Plan and ramping up climate resilient infrastructure investment. - Strengthen PFM and climate finance capacity. - Enhance climate preparedness by sustaining progress in disaster risk data reporting and adopting national building codes to address structural gaps and strengthen long‑term resilience. - Structural reforms to unlock private‑sector‑led growth (paragraph 45): - Implement bold structural reforms: streamline business regulations, digitalize regulatory processes, create a more open and predictable environment for foreign investment through harmonized and transparent investment rules, and enable access to long‑term land‑lease arrangements. - Combined with measures to address skills mismatches, these reforms can support creation of high‑quality jobs and ease emigration pressures. - Data gaps and statistical improvements (paragraph 46): - Continue efforts to close data gaps with development partner support. - Timely compilation of macroeconomic statistics is essential for effective decision‑making. - Explore avenues for utilizing new information management systems in statistical compilation. *Source: Extracted content from the provided PDF content unit.* ### 47. It is recommended that the next Article IV consultation be held on a 24-month cycle. ### 47. It is recommended that the next Article IV consultation be held on a 24-month cycle. ### Real sector developments - FY2024: economic rebound. - FY2025: rebound not sustained, reflecting a slowdown in the execution of public investment. - Outmigration: loss of workers due to outmigration more pronounced in the private sector. - Real GDP growth heterogeneous across states (average annual growth rate of 2015-23, in percent): - Chuuk, Pohnpei, Kosrae, Yap: states displayed differing growth rates (chart presented in source). - Inflation: - Eased in FY2025, supported by lower prices of domestic items and the lagged impact of easing global commodity prices. - Employment (number of workers): private and public employment series shown across FY2005–FY2024 (chart presented in source). ### Fiscal developments - Fiscal surplus has narrowed due to a decline in revenues from corporate income taxes and fishing fees. - State governments contributed to most of the recent fiscal surplus, thanks to the revised revenue sharing rule. - Capital spending remains below pre-pandemic levels. - Sectoral public spending: - Public spending on health is low while education expenditure is relatively high (Pacific Islands comparison). - Trust funds: - FSM’s trust fund balance continued to grow, albeit at a slower pace due to a decline in the surplus. - Compact trust fund (CTF) balances rose sharply, thanks to additional upfront US contributions in 2024-25. Key fiscal figures (Table 1 highlights): - Nominal GDP (FY2023): US$443 million - Population (FY2023): 94,654 - GDP per capita (FY2023): US$4,680 - IMF Quota: SDR 7.2 million - FY2024–FY2030 projections (selected): - Real GDP: FY2024 2.3; FY2025 1.1; FY2026 0.7; FY2027 1.1; FY2028 1.4; FY2029 1.0; FY2030 0.7 (annual percent change) - Consumer prices: FY2024 5.4; FY2025 3.2; FY2026 3.2; FY2027 4.0; FY2028 1.7; FY2029 2.0; FY2030 2.0 (annual percent change) - Revenue and grants (percent of GDP): FY2022 76.1; FY2023 61.3; FY2024 61.5; FY2025 60.6; FY2026 62.4; FY2027 66.6; FY2028 69.3; FY2029 69.2; FY2030 64.8 - Tax revenue (percent of GDP): FY2022 26.9; FY2023 13.3; FY2024 13.8; FY2025 12.6; FY2026 15.6; FY2027 15.8; FY2028 15.6; FY2029 15.6; FY2030 15.5 - Fishing license fees (percent of GDP): FY2022 17.6; FY2023 16.1; FY2024 15.1; FY2025 13.5; FY2026 13.8; FY2027 13.1; FY2028 12.7; FY2029 12.3; FY2030 12.0 - Net lending/borrowing (percent of GDP): FY2022 16.8; FY2023 -1.8; FY2024 1.7; FY2025 0.4; FY2026 0.4; FY2027 -0.3; FY2028 -0.6; FY2029 -0.8; FY2030 -0.9 - Public debt (end of period, percent of GDP): FY2022 15.1; FY2023 12.8; FY2024 10.4; FY2025 8.9; FY2026 7.5; FY2027 7.3; FY2028 7.7; FY2029 8.4; FY2030 9.1 - Balance of trust funds (Compact Trust Fund + FSM Trust Fund, in millions of U.S. dollars): FY2022 298.1; FY2023 325.6; FY2024 412.9; FY2025 509.6; FY2026 517.3; FY2027 518.2; FY2028 528.4; FY2029 539.2; FY2030 551.5 ### External sector developments - Current account: registered a surplus in recent years, financed by fishing license fees, foreign grants and corporate tax windfalls. - Trade: limited exports and local production led to large trade deficits; many essential items (food and fuel) are imported. - Trade partners: - Main export partners related to fishing industry supply chains; imports come mostly from Guam and the United States. - Main export and import composition (2019 and 2019/2024 data in source): - Main export products (2019): Offshore fish 82.0%; Betel nuts 8.7%; Others 3.4%; Kava 2.0%; Reef fish 1.2%; Live clams 1.0%. - Main import products (2019): Food and drink 27%; Fuels 17%; Motor vehicles and parts 7%; Machinery equipments 6%; Construction materials 4%; Tobacco 2%; Others 37%. - Balance of payments (Table 3 highlights, in millions of U.S. dollars): - Current account balance: FY2022 68.6; FY2023 24.4; FY2024 16.6; FY2025 18.9; FY2026 5.7; FY2027 -2.2; FY2028 -4.2; FY2029 -6.7; FY2030 -6.6; FY2031 -5.9 - Trade balance (goods and services): FY2022 -183.8; FY2023 -189.2; FY2024 -207.7; FY2025 -204.3; FY2026 -227.4; FY2027 -254.0; FY2028 -269.2; FY2029 -276.9; FY2030 -270.2; FY2031 -268.3 - Fishing license fees (receipts, millions): FY2022 71.3; FY2023 69.8; FY2024 70.5; FY2025 65.8; FY2026 69.7; FY2027 69.6; FY2028 69.5; FY2029 69.4; FY2030 69.4; FY2031 69.3 - Private and official transfers (millions): FY2022 218.3; FY2023 192.1; FY2024 206.5; FY2025 212.7; FY2026 221.0; FY2027 241.3; FY2028 255.7; FY2029 262.1; FY2030 256.3; FY2031 255.9 ### Monetary and financial sector developments - Bank deposits continue to rise while loans were relatively flat. - Loan-to-deposit ratio remains at historically low levels and below other Pacific Island Countries (PICs). - Excess deposits invested in deposits and investment securities with banks abroad. - Financial deepening lags peers. - Domestic lending dominated by consumer credit. - Interest rates on commercial loans fell as deposits grew. Commercial bank indicators (selected): - Commercial bank deposits vs. loans (in millions of U.S. dollars, source charts for FY2004–FY2025). - Loan-to-deposit ratio (Table 5 memorandum): FY2020 13.2; FY2021 11.8; FY2022 12.8; FY2023 11.6; FY2024 11.2; FY2025 10.8 (in percent) - Deposits (in percent of GDP, Table 6): FY2023 100.0; FY2024 92.0; FY2025 96.4; FY2026 94.3; FY2027 93.2; FY2028 92.1; FY2029 91.0; FY2030 89.9; FY2031 88.8 - Loans (in percent of GDP, Table 6): FY2023 11.6; FY2024 10.3; FY2025 10.4; FY2026 10.6; FY2027 10.8; FY2028 11.0; FY2029 11.2; FY2030 11.4; FY2031 11.6 Financial soundness indicators (selected, Table 7): - Regulatory capital to risk-weighted assets: Jun-21 40.6; Dec-21 37.2; Jun-22 38.1; Dec-22 38.5; Jun-23 37.4; Dec-23 38.9; Jun-24 43.9; Dec-24 42.1; Jun-25 44.6; Sep-25 43.3 - NPL to total gross loans: Jun-21 0.7; Dec-21 1.3; Jun-22 1.2; Dec-22 1.4; Jun-23 1.6; Dec-23 1.7; Jun-24 0.9; Dec-24 2.8; Jun-25 3.4; Sep-25 7.5 - Return on assets: Jun-21 0.6; Dec-21 0.7; Jun-22 0.9; Dec-22 3.3; Jun-23 3.0; Dec-23 3.4; Jun-24 3.1; Dec-24 3.0; Jun-25 2.6; Sep-25 2.6 ### Structural bottlenecks to growth - Major constraints: heavy regulatory burdens for businesses and weak institutions. - Geography: dispersion and remoteness hinder physical connectivity. - High cost of doing business relative to peers. - Digital and mobile technology access: increasing access could enhance connectivity. - Indicators (source charts): - Individuals using the internet (percent of population, 2021): comparisons across PICs with Micronesia among lower adopters (chart). - Rule of Law and Business Regulatory Environment: Micronesia scores reflect challenges versus peers. - Liner Shipping Connectivity Index and 3G mobile network coverage: show limited connectivity. ### Climate change adaptation - FSM is among the most climate-vulnerable countries in the Pacific region. - Ranks fourth in projected economic losses per unit of GDP (2000-2019 ranking among PICs). - Climate readiness remains below other PICs despite improvements. - Climate adaptation hindered by weak implementation and resource constraints. - Climate indices (source charts): - Adaptive Capacity Index vs. nominal GDP per capita (USD, 2018) shows limited adaptive capacity relative to higher-income countries. - Long-term Climate Risk Index and Climate Readiness and Vulnerability Indices (2023) show elevated vulnerability and lower readiness relative to PICs, Asia EMDEs, and LICs. ### Key projections and medium-term outlook - Real GDP (annual percent change): FY2024 2.3; FY2025 1.1; FY2026 0.7; FY2027 1.1; FY2028 1.4; FY2029 1.0; FY2030 0.7. - Consumer prices: FY2024 5.4; FY2025 3.2; FY2026 3.2; FY2027 4.0; FY2028 1.7; FY2029 2.0; FY2030 2.0. - Current account balance (percent of GDP): FY2024 3.5; FY2025 3.8; FY2026 1.1; FY2027 -0.4; FY2028 -0.7; FY2029 -1.1; FY2030 -1.1. - Compact Trust Fund and FSM Trust Fund balances projected to continue rising over FY2024–FY2031 (specific series in Tables 2a and 2b). ### Policy recommendations (implied by developments and the Article IV recommendation) - Hold the next Article IV consultation on a 24-month cycle (explicit recommendation). - Fiscal policy priorities implied by the data: - Strengthen revenue performance and stabilize reliance on fishing license fees and grants. - Prioritize capital spending execution to sustain growth momentum. - Maintain trust fund oversight as balances rise, ensuring sustainability given projected slower surplus growth. - Financial sector priorities: - Encourage financial deepening to raise loan-to-deposit ratios toward peer levels. - Support measures to channel excess deposits into productive domestic investment. - Structural and climate priorities: - Streamline business regulatory environment and strengthen institutions to reduce bottlenecks. - Invest in physical and digital connectivity to lower the cost of doing business. - Mobilize resources and strengthen implementation capacity for climate adaptation. *Source: Federated States of Micronesia — IMF staff report figures, tables, and projections as presented in the provided content unit.* ### Annex I. Country Engagement Strategy ### Annex I. Country Engagement Strategy ### A. Drivers of Fragility - Geography and demography - FSM is a federation of four states—Pohnpei, Chuuk, Yap, and Kosrae—spanning over 600 islands and an Exclusive Economic Zone of approximately 3 million km². - Arable land: 2.8 percent of land area; total agricultural land of approximately 50km2, mainly for subsistence farming. - Population estimated at around 95,000; the latest (2023) unpublished census suggests it is substantially lower due to outward migration. - GDP per capita: USD 5,089 in 2024. - Political and institutional features - Highly decentralized political structure with significant autonomy for states; decentralization complicates coordination and consensus-building. - COFA with the United States remains central to economic and development trajectory; the renewed COFA agreement (2024) provides USD 2.8 billion in sector grants through 2043. - FSM’s trust funds have accumulated assets of roughly 510 percent of GDP by FY2025. - Climate, connectivity, and infrastructure - Climate adaptation needs estimated at around 30 percent of 2024 GDP, annually. - Climate change projected to reduce tuna catches by 13 percent, potentially lowering GDP by 4 percent. - Loss of small islands may shrink the EEZ and impact fishing license revenues. - Maritime connectivity is among the worst even within PICs; some outer islands have marine transport services only on a biannual basis. - Air connectivity ranks 210 out of 219 countries. - Access to electricity and quality of critical infrastructure (water, energy) lag peers; infrastructure deteriorating due to inadequate maintenance and climate effects. - Economic structure and labor - Narrow economic base dominated by the public sector; public sector employs over half of the workforce. - Growth averaged only 1.0 percent in the decade pre-COVID. - Outward migration, particularly to the US, has exacerbated skilled labor shortages and increased reliance on international labor mobility. - Aid dependency pronounced: donor grants represent nearly half of fiscal revenue. ### B. Constraints to Reforms and Policies to Address Fragility - Capacity and governance constraints - Weak institutional capacity in procurement, financial management, monitoring and evaluation; weak public financial and investment management frameworks. - Significant loss of civil servants between 2019 and 2022 (12 percent), worsening administrative capacity and skills shortages. - Heavy use of international consultants has not produced sustained domestic capacity due to high turnover. - Decentralized structure requires consensus between national and state governments for many reforms (taxation, land, business regulation, FDI), creating administrative fragmentation and inter-state tensions. - Allocation of COFA funds is a key source of inter-state friction despite oversight by the Joint Economic Management Committee. - Policy priorities and implementation challenges (summary of priority areas) - Revive reform momentum: implement an ambitious, mutually reinforcing, transformative reform package requiring broad consensus across states and international support; use effective communication strategies to build support and mitigate adverse effects. - Strengthen public financial management (PFM): develop a medium-term fiscal framework and public investment management capacity; seek development partner support for project prioritization and implementation; increase transparency and accountability in PFM. - Remove obstacles to private sector development: simplify business regulations, pursue land reform, ease FDI restrictions, address skills mismatches, and strengthen transportation and communication (including digital) infrastructure; improve access to credit through supply- and demand-side measures. - Address climate and food security: prepare a comprehensive National Adaptation Plan; integrate climate strategies into PFM; undertake hazard mapping for key infrastructure. ### C. International Partnerships and Fund Engagement including Capacity Development Priorities - IMF engagement focus - Fund engagement should center on surveillance and capacity development (CD). - Recent CD delivered mainly by PFTAC with headquarters support: compilation of macroeconomic statistics, development of a macro-fiscal projections tool, tax policy reform design, and strengthening financial sector supervision. - Near-term CD priorities: enhance capacity for prioritizing and implementing public investments effectively. - Specific CD support areas: improve timeliness of macroeconomic statistics; close data gaps (e.g., Balance of Payments compilation); improve PFM and public investment management (including climate integration); revenue mobilization (including support to implement a VAT). - Recommend a medium-term CD approach with on-the-job training to improve knowledge transfer and account for potential turnover of officials. - Close coordination with development partners is crucial; major partners include the US, World Bank, Asian Development Bank, United Nations agencies, Australia, New Zealand and Japan. - Implementation status of selected prior recommendations and reforms - PFM and administrative systems - Payroll module of Financial Management Information System rolled out at state and national level in October 2025. - PFM Reform agenda largely completed introduction of new information systems, while progress in strengthening public investment management remains pending. - Tax administration and digital systems - ASYCUDA system operationalized in March 2024. - Revenue Management System launched in August 2025. - National Tax Reform Task Force concluded consultations with all states in December 2025. - Digital connectivity - Entry level broadband service made available throughout FSM in May 2025. - Legal and regulatory frameworks for digital government services drafted; pilot government services being rolled out. - National Adaptation Plan - National Adaptation Plan is planned for completion in 2026. - Unimplemented items noted - Amendments to the Foreign Investment Act to harmonize FDI laws across states: Not implemented. - Reform of land tenure system: Not implemented. - Enhance institutional framework for FSMDB and address corporate governance gaps: Not implemented. - Extend FSM Banking Board supervisory authority to FSMDB and credit unions: Not implemented. - Risks to Fund engagement and reform implementation - Ongoing emigration and labor shortages constrain domestic capacity. - Fiscal vulnerabilities from uncertainties in tax revenues, external grant flows, and unexpected climate-related expenditures. - Political fragmentation and limited political will that can undermine policy continuity. - Persistent climate change vulnerabilities exacerbating economic and social fragilities. ### D. External Position and Related Findings (Annex III highlights relevant to engagement) - Current account and external position (FY2024–FY2025 and model assessments) - FY2025 current account balance estimated surplus: 3.8 percent of GDP. - FY2024 current account surplus: 3.5 percent of GDP. - Increase in foreign corporate tax revenue from 2.4 to 4 percent of GDP between FY2024 and FY2025. - Net international investment position (NIIP) of 192 percent of GDP at end-FY2025. - Adjusted current account balance (after model-based cyclical contributions): surplus of 4.1 percent in FY2025. - EBA-lite current account norm: -1.5 percent of GDP. - Model-estimated current account gap: around 5.6 percent of GDP. - Identified policy gaps: about 5.9 percent of GDP, mainly attributed to tight fiscal policy and capacity constraints in public investment execution. - Assessment and implications - The external position is assessed to be substantially stronger than the level implied by fundamentals and desirable policies, but with considerable uncertainty due to data gaps and volatility in major BOP flows (foreign grants, fishing license fees, foreign corporate tax revenue). - New COFA agreement significantly strengthens external position by providing a substantial and reliable increase in capital inflows and financial support, and implies a reduced need for savings. - As the current account surplus is projected to narrow over the medium to long term, structural reforms to promote private sector development are recommended to improve competitiveness, diversify exports, and reduce import reliance. *Prepared by Salote Cirikisuva and Choonsung Lim; material summarized from Annex I. Country Engagement Strategy.* ### 0.24 percent and 0.8 percent (monthly average) ### 0.24 percent and 0.8 percent (monthly average) ### Use of the U.S. dollar and monetary assessment - The use of the U.S. dollar as the official currency is appropriate given the small size of the economy, close financial and trade linkages with the United States, and limited administrative capacity for independent monetary and exchange rate policies. - FSM is fully dollarized and lacks an independent monetary policy framework, preventing construction of the real short‑term interest rate variable required by the EBA‑lite REER specification. ### Capital and Financial Accounts - Background: - The capital account surplus is estimated to be 3.3 percent of GDP in FY2025, mainly composed of inflows of capital grants from the U.S. Compact and other IFIs or donors. - Foreign direct investment (FDI) is likely to remain a negligible source of financing. - The portfolio investment account is projected to increase, driven by returns on government investment in foreign securities. - Assessment: - The new COFA agreement represents stability in the capital account inflow and the continued surplus of capital and financial accounts in the medium term. ### FX intervention, reserves, and government deposits - The FSM does not have a central bank or foreign exchange reserves. - The national government’s bank deposits fell to around 13.8 percent of GDP at end-FY2025 from 17 percent of GDP at end-FY2023, following changes in revenue-sharing rules with state governments. - The end-FY2025 balance corresponds to more than 2 months of imports and more than 2 months of general government’s current expenditure. - Assessment: - Government deposits could play a role in absorbing short-term liquidity shocks. - Note on REER and external sustainability approaches: - The Real Effective Exchange Rate (REER) approach in the EBA‑lite framework is not applied due to data and structural limitations (FSM is fully dollarized and lacks required data and policy variables). - The external sustainability approach is not applicable, given FSM’s positive net international investment position in both historical and projection periods. - The NIIP does not include accumulated U.S. contributions to the Compact Trust Fund. ### Risk Assessment Matrix — key risks, likelihood/time horizon, expected impact, and policy responses - Accelerating reform momentum - Relative Likelihood/Time Horizon: Medium / MT - Expected Impact: High - Main impacts → Recommended Policy Actions: - Implementation of growth-friendly structural reforms reinvigorates the private sector, improves climate change resilience and boosts potential growth. - → Build fiscal buffers at a faster pace. - → Increase investment in adaptation. - Slow implementation of infrastructure projects - Relative Likelihood/Time Horizon: High / MT - Expected Impact: Medium - Main impacts → Recommended Policy Actions: - Slow implementation will depress potential growth and could lead to greater emigration. - → Deepen collaboration across stakeholders to address bottlenecks in implementation. - Commodity Price Volatility - Relative Likelihood/Time Horizon: High / ST, MT - Expected Impact: Medium - Main impacts → Recommended Policy Actions: - Increase inflation volatility and contribute to cost-of-living pressures as the bulk of food is imported and electricity generation relies on imported diesel. - → Provide targeted fiscal assistance to vulnerable households, accelerate transition to renewable energy, and increase domestic food production. - Climate Change - Relative Likelihood/Time Horizon: Medium / ST, MT and LT - Expected Impact: High - Main impacts → Recommended Policy Actions: - Extreme climate events cause loss of life, damage to infrastructure, food insecurity, supply disruptions, and heighten economic and financial instability. - → Deploy contingency funds to provide immediate relief, before seeking additional support through COFA. - → Strengthen fiscal buffers to help finance immediate disaster response. - → Finalize the National Adaptation Plan, speed up implementation of adaptation investment projects, improve data systems for managing disaster risks, strengthen capacity for public investment management, and mobilize external grant financing. - Disorderly AI Correction - Relative Likelihood/Time Horizon: High / ST, MT - Expected Impact: Medium - Main impacts → Recommended Policy Actions: - Sharp market corrections could result in large losses in the trust funds, eroding fiscal buffers. - → Mobilize domestic revenue to diversify and expand the country’s revenue base. - → Continue to transfer windfall gains into the FSM trust fund. - Geopolitical Tensions and Intensification of Conflicts - Relative Likelihood/Time Horizon: High / ST - Expected Impact: Medium - Main impacts → Recommended Policy Actions: - Tensions may cause withdrawal of cash and in-kind grants, increases in input costs, inflationary pressure, and greater financial frictions affecting cross-border payment channels. - → Mobilize domestic revenue to diversify revenue base away from grants. - → Diversify sources of critical imports to enhance supply chain resilience. - → Implement structural reforms to reinvigorate the private sector and reduce reliance on the public sector for economic growth. - → Prepare alternative payment channels e.g., through participation in the Pacific CBR project. - New Trade Agreements - Relative Likelihood/Time Horizon: Low / Medium - Expected Impact: Medium - Main impacts → Recommended Policy Actions: - Progress in trade talks would expand export markets and support private sector growth. - → Communicate new export opportunities through awareness-raising campaigns and provide a dedicated focal point to help business navigate export requirements. - → Upgrade logistics infrastructure to meet increased volumes. - → Accelerate regulatory reforms to improve ease of doing business. ### Potential gains from tax reform — findings, reform package, and revenue estimates - Overview: - Tax policy reforms could increase government revenue, support investment and improve efficiency. - Key proposals include introducing a 10 percent VAT, converting import duties into excises, and replacing the gross revenue tax with a net profits tax. - These reforms are projected to increase net revenue by 1.5 percent of GDP, with the VAT generating the largest portion. - Institutional and historical context: - FSM reconstituted the National Taskforce on Tax Reform in 2025 to propose tax policy and administration reform options. - Previous attempts at major tax reform, including a 2021 VAT attempt, failed due to lack of consensus across states and private sector reticence. - The launch of the revenue management system in July 2025 creates a favorable environment for implementing tax reforms because it can support better compliance and reporting. - Based on a stochastic tax frontier analysis covering panel data for 188 countries from 2002 to 2023, FSM’s actual tax revenue falls short of its potential by over six percentage points. - Recommended tax reform package: - Introduce a 10 percent VAT with a registration threshold of USD100,000 to replace the current state sales taxes on goods and services. Business inputs and investment goods would not be subject to a VAT. - Convert existing import duties to excises on certain goods (tobacco, alcohol, fuel, sugary products, motor vehicles). The excises are the same as the current duty rates. - Introduce a tax-free threshold of USD5,000 for the Wages and Salaries Tax (WST), replacing the existing low-income deduction of USD1,000. - Repeal the Gross Revenue Tax (GRT) and replace it with a Net Profits Tax (NPT) of 25 percent and a presumptive tax of USD150 for businesses with a turnover below USD10,000. - Introduce Withholding Taxes (WHT) of 15 percent on payments to non-residents, additionally covering dividends and technical service fees. - Revenue estimates and mechanics: - The proposed tax reform is estimated to increase net revenue by 1.5 percent of GDP. - With limited exemptions, the impact on tax revenue collection is 2.1 percent of GDP; the net impact on the government budget is smaller, an increase of 1.5 percent GDP (because VAT is applied to government purchases, increasing government expenditure). - Replacing or modifying existing taxes (import taxes, state sales taxes and excises, GRT, and WST) is estimated to reduce tax revenue by 10.7 percent of GDP. - New taxes (VAT, NPT, and excises) are expected to generate 12.8 percent of GDP. - VAT alone is projected to raise revenue by 7.4 percent of GDP at a rate of 10 percent. - A 12.5 percent VAT rate would increase revenue to 9.3 percent of GDP. - An 8 percent VAT rate would generate 5.9 percent of GDP. - For comparison, in 2021 the average main VAT rate was 12 percent for Pacific Island countries and 16 percent globally. - Experiences from peers and implementation considerations: - Palau introduced a 10 percent VAT (PGST) with a USD300,000 registration threshold in 2023, eliminated import duties, introduced a Business Profits Tax, and lowered wage and salary taxes. Tax-to-GDP rose from 18.1 percent before reforms to 21.6 percent in FY2023 and 22.8 percent in FY2024. - RMI’s tax reform is progressing in two phases; the second phase (planned for FY2027) would replace GRT and import duties with a 12 percent VAT and introduce a Business Profit Tax for large firms. - For successful reform in FSM, securing support from individual states, the private sector, and the public is crucial. Yap requires resolution of a state constitutional issue before implementation can proceed. - Revenue sharing arrangements should consider the public service responsibilities of each level of government. - Effective communication strategies and targeted measures (e.g., USD5,000 tax-free WST threshold and targeted transfers for the most vulnerable) can reduce public resistance. - Capacity development will be needed to support the introduction of a VAT. *Source: IMF staff estimates.* ### Annex VI. Financial Sector Reforms for Development ### Annex VI. Financial Sector Reforms for Development ### Overview and objectives - Transitioning to private sector-led growth is needed to secure long-term economic resilience and move the economy beyond heavy reliance on the public sector. - A more dynamic financial sector is required to actively channel domestic credit and enable broader economic participation. - Effective reform must prioritize measures addressing both supply-side reluctance to lend and demand-side inability to qualify for credit. ### Key statistics and context - Deposit base: almost matching GDP. - Share of deposits channeled into domestic credit: only 10 percent. - Secured Transactions Act enacted: 2006. - Development and Finance Training Institute (DFI) established: 2014. - Digital connectivity milestone: submarine fiber optic cable landing in Kosrae, now all four FSM states (Yap, Chuuk, Pohnpei, and Kosrae) have access to fast, reliable international broadband. ### A. Addressing supply-side constraints: collateral, digital infrastructure, and risk Findings - The main barrier to credit expansion is the lack of legally viable collateral; traditional land ownership restrictions prevent using real estate as loan security. - Commercial banks treat most domestic lending as unsecured and hold high liquidity buffers offshore, reflecting institutional risk aversion. - The Secured Transactions Registry (STR) enables use of movable assets (inventory, equipment, accounts receivable) as collateral, but practical impact on credit expansion has been limited. - Movable assets typically have lower recoverable values; STR is mostly used for small commercial loans and has not led to a significant increase in business financing. - Digital infrastructure (submarine cable in Kosrae; satellite rollout to outer islands supported by the World Bank) removes physical barriers to financial access and lays the foundation for digital credit expansion. - Banks are rolling out digital services: Bank of FSM (BFSM) launched a Consumer Internet Banking platform and mobile app with mobile check deposits, peer-to-peer (P2P) payments, and fund transfers; Bank of Guam (BoG) provides comprehensive digital banking services. - Pilots for digital provision of inter-island ferry booking will support take-up of digital payments. Policy implications and recommendations - Use STR‑backed lending to help small businesses access their first, lower‑value loans to build credit histories. - Combine STR‑backed lending with digital transactions and tax records to support gradual qualification for larger loans assessed with data‑driven credit‑evaluation methods. - Leverage expanded broadband and lower broadband costs to accelerate digital banking and broaden financial inclusion. ### B. Addressing demand-side constraints: literacy, tax reform, and cooperation Findings - Widespread informality among SMEs limits access to credit: many lack financial management skills and accounting systems to produce verifiable financial statements. - Banks view informal SMEs as high-risk, constraining private sector growth. - FSMDB’s DFI offers targeted courses such as “Financial Accounting for Non-Accountants and Competitive Business Strategy for Entrepreneurs and Small Businesses” to help SME owners formalize operations and improve financial recordkeeping. - The World Bank-backed Revenue Management System (RMS) creates an end-to-end digital audit trail of business activity, but the Business Gross Receipts Tax requires minimal reporting and limits RMS utility for credit assessment. - Introducing a value‑added tax (VAT) would compel firms to track inputs and outputs, generating more granular profitability data for credit‑risk modeling. - There is no regulated data-sharing protocol between the RMS (tax authority) and financial institutions (BFSM, BoG, FSMDB); tax and transactional data remain largely inaccessible to lenders. - Any data-exchange mechanism must adhere to data privacy and data protection principles and be consent-based; India’s consent‑based data‑sharing experience is cited as illustrative. - Credit unions have local reach in remote areas but currently operate outside FSM Banking Board (FSMBB) supervision, constraining co-lending and risk-sharing partnerships with commercial banks. Policy implications and recommendations - Expand the reach and curriculum of the DFI; integrate financial literacy into entrepreneurship and vocational training. - Incentivize participation by linking training completion to loan eligibility; co-deliver training, mentorship, and certification with development partners and financial institutions. - Modernize tax administration toward VAT to improve data quality for credit-risk modeling and strengthen the RMS’s role in supporting credit expansion. - Strengthen legal frameworks governing electronic transactions, data protection and privacy, cybercrime, and online consumer protection to reinforce confidence in digital financial systems. - Design and implement a regulated, consent‑based data-sharing protocol to enable secure exchange of tax compliance and transactional data between taxpayers and lenders. - Bring credit unions and the FSMDB under FSMBB supervision to establish governance, risk management, and reporting standards necessary for safe inter-institutional cooperation. - Introduce cooperation models like agency banking leveraging credit union networks for loan origination, monitoring, and collection to reach the last mile. *Prepared by Nur M. Adhi Purwanto — Annex VI. Financial Sector Reforms for Development* ### 11. With these calibrations, the following section presents a scenario-based analysis to evaluate ### 1fsmea2026001-source-pdf - 11. With these calibrations, the following section presents a scenario-based analysis to evaluate ### Scenario descriptions and key assumptions - Recovery assumption: - The economy is assumed to recover from the disaster by 2033. - Shock magnitudes in year of the disaster (2030): - Tradable output decline: 13 percent. - Non-tradable output decline: 4 percent. - Baseline Scenario (Scenario 0): - Public investment 2026–2030: additional 0.9 percent of GDP in standard infrastructure and 0.1 percent of GDP in resilient infrastructure annually. - Financing: all additional investment financed by grants. - Reconstruction after 2030 disaster financed through concessional debt. - Scenario 1: Scale-Up with Concessional Borrowing - Public investment 2026–2030: 0.9 percent of GDP in standard infrastructure and 1.1 percent of GDP in resilient infrastructure. - Financing: additional investment financed by concessional borrowing. - Reconstruction after 2030 financed by concessional debt. - Scenario 2: Scale-Up with Grants - Same investment profile as Scenario 1 (0.9 percent standard, 1.1 percent resilient from 2026–2030). - Financing: all additional public investment financed with grants. - Reconstruction after 2030 financed by concessional debt. - Scenario 3: VAT Reform with Extra Resilient Investment - Investment scale-up as in Scenario 1. - Permanent resilient investment after 2030 at 1 percent of GDP. - Domestic revenue mobilization via permanent VAT reform starting in 2027 that raises an additional 1.5 percent of GDP in revenue. - 0.5 percent of GDP of additional revenue given back to households as transfers. - 1 percent of GDP finances the permanent resilient investment. - Reconstruction after disaster financed by concessional debt. - Scenario 4: VAT & PIE Reform with Extra Resilient Investment - Builds on Scenario 3. - Public investment efficiency (PIE) increased from 50.0 percent to 70.0 percent. - All extra public investment financed by VAT revenue. - Reconstruction after disaster financed by concessional debt. ### Calibrated parameters and initial values (in percent) - Grants to GDP ratio: 28.2 - Public domestic debt to GDP ratio: 1.0 - Public concessional debt to GDP ratio: 9.1 - Public external commercial debt to GDP ratio: 0.5 - Return to standard infrastructure: 25.0 - Return to climate-resilient infrastructure: 30.0 - Public standard infrastructure investment to GDP ratio: 11.0 - Depreciation rate of standard public infrastructure: 7.5 - Depreciation rate of resilient public infrastructure: 3.0 - Public investment efficiency: 50.0 - Share of capital in tradable sector: 40.0 - Share of capital in non-tradable sector: 55.0 ### Simulation results and quantitative findings (DIGNAD model) - General finding: - Preemptive public investment in resilient infrastructure mitigates economic damage from natural disasters and strengthens long-term debt sustainability. - Effect of scaling up resilient investment (Scenarios 1 and 2) relative to Baseline: - Real GDP loss from the natural disaster reduced from 6.1 percent to 2.9 percent. - Note: simulations assume zero real interest rates on concessional borrowing; hence Scenarios 1 and 2 yield the same real outcomes but different debt levels. - VAT reform effects (Scenario 3): - VAT creates additional fiscal space enabling resilient investment and reduces reliance on external grants and concessional borrowing. - Persistent public investment leads to strong recovery in real GDP and private investment; both remain about 1 percent above their 2025 levels ten years after the natural disaster. - Public debt-to-GDP ratio in 2040 is around 1.8 percentage points lower relative to Scenario 2 and follows a declining trajectory. - Short-run: higher tax rate dampens private consumption; long-run: improvement in GDP growth and transfers bring consumption back to baseline levels. - Combined VAT + PIE reform (Scenario 4): - Amplified gains: real GDP growth and private investment rise to around 2 percent above their initial levels in the long run. - Public debt-to-GDP ratio remains fully contained and declines below its 2025 level. - Private consumption faces a muted impact of the shock and recovers to be above its initial level. ### Policy implications and recommendations - Priority: Scale up climate-resilient infrastructure. - Rationale: Upfront costs are higher, but resilient investment substantially reduces future disaster-related losses and limits reconstruction spending. - Recommendation: Embed climate-proofing standards in all new public projects to improve long-term value for money. - Improve public investment management (PIM): - Actions: Strengthen project preparation, procurement processes, and coordination between national and state authorities to improve implementation timelines and absorptive capacity. - Outcome: Gains in investment efficiency can meaningfully raise growth dividends and support debt sustainability. - Domestic revenue mobilization, notably VAT introduction: - Benefit: Creates predictable fiscal space for priority investments and reduces reliance on external grants. - Design elements: A well-designed VAT accompanied by improvements in compliance and administration would strengthen fiscal buffers while maintaining essential services and scaling up adaptation efforts. - Maintain a prudent financing mix: - Recommendation: Use concessional borrowing for high-impact, climate-resilient infrastructure and post-disaster recovery while maximizing access to external climate finance facilities. - Complementary action: Strengthen PFM and fiduciary systems to better prepare projects and utilize climate funds effectively. - Broader structural reforms: - Areas: Improve the business environment, address land-related constraints, and advance digitalization. - Purpose: Encourage private sector activity and support long-term, resilient growth. --- ### Annex VIII — Labor market and migration: key findings and policy points - Labor market characteristics: - Labor force participation rate (LFPR) in FSM (Population Census 2010): about 57 percent. - More than half of those employed worked in the informal sector (home production); about 26 percent of formal workers also engaged in home production. - Chuuk (2010): LFPR 53 percent; share of informal workers among employed persons 64 percent; unemployment rate 25 percent. - Female-to-male LFPR ratio: 73 percent. - Female share of informal employment: 58 percent. - Employment trends and composition: - Population decline over last decade; population lower than the level in 1989. - Private sector employment declined about 11 percent from 2010–2024. - In 2024, private sector losses nearly matched public sector gains (public sector is largest employer). - In the private sector, most workers employed in wholesale and retail trade and repairs, transport storage, communications and education sectors. - Reliance on foreign workers: - Foreign work permits mostly for private sector (76 percent). - Share of employment that is foreign workers: about 15 percent in private sector and 4 percent in public sector. - Major source countries: neighboring Pacific Islands (27 percent), the Philippines (26 percent), and others from China and other Asian countries. - Philippines ban on sending new workers to FSM in 2018 (lifted in 2023) affected skilled migrant supply. - Wages and retention: - Civil service wages were increased by 45 percent at the national level; states followed with similar increases. - Many FSM citizens who migrate abroad can earn up to twice the average wage available at home. - Migration trends and consequences: - OECD reports number of FSM citizens residing in the US grew by around 53 percent between 2020 and 2023. - Migrants are relatively young and more educated than general FSM population; departure causes skill shortages in education, healthcare, and technology sectors. - Many FSM migrants in the US work in labor-intensive industries; those who study in the US often do not return due to scarce suitable jobs at home. - Trend contributes to brain drain, reducing productivity and limiting potential growth rate. - Drivers of migration: - Migration in FSM tends toward more permanent diasporas compared to some PICs that have circular migration schemes. - Push factors: limited economic opportunities, accessibility of US labor market, better economic and educational opportunities abroad, improved healthcare, family reunification. - The pandemic and recent cost of living crisis may have accelerated outward migration. - Policy recommendations to address labor/migration issues: - Revitalize private sector through structural and financial reforms to create employment and retain workers. - Enhance employability by improving education quality and vocational training; introduce active labor market programs. - Support vocational training for fostering green jobs, considering climate vulnerability. - Strengthen quality of education; increase teachers with higher education backgrounds. - Reinforce mechanisms to enforce return conditions tied to scholarships. - Engage in active labor market and skills development initiatives (e.g., World Bank project on skill development). - Raise female labor force participation to help alleviate labor shortages, while addressing structural and social challenges. - Multisectoral migration task force led by the Department of Justice to address drivers of migration and reintegration. *Source: IMF staff calculations; IMF DIGNAD model simulation results; and IMF staff estimates (as presented in the source content).* ### 8. Better engagement with the diaspora can support economic development. Given its ### 8. Better engagement with the diaspora can support economic development. ### Findings on migration, labor market, and remittances - FSM has one of the highest emigration rates amongst PICs at 39.2 percent. - Despite high emigration, inward remittances are described as "relatively low," suggesting large permanent diasporas and concentration of migrants in low-wage sectors abroad. - FSM migrants to the United States tend to have higher education than general FSM citizens and work in hospitality, trade, and manufacturing. - Average earnings in FSM are low and "far below those earned by migrants in labor-intensive jobs overseas." - Destination patterns include increased numbers of Micronesians living in the US and relocations to Guam and the Northern Mariana Islands. ### Comparative and programmatic examples - Samoa: has a dedicated Diaspora Relations Unit to foster ties and investment. - New Zealand: the "Return to Roots" program had seen some success during its introduction. - These examples are cited as models for the FSM to consider when prioritizing diaspora engagement over reintegration programs. ### Policy recommendations and enablers for FSM - Prioritize a diaspora engagement strategy (rather than focusing primarily on reintegration programs). - Improve digital and financial infrastructure to support diaspora engagement and related initiatives. - Design initiatives that recognize the permanent nature of much of the FSM diaspora and the concentration of migrants in low-wage sectors abroad. ### Data and monitoring implications - Improving labor market and migration statistics is recommended to better monitor developments and inform policy design. - Staff encourage authorities to publish the 2023 Population Census to help fill data gaps relevant to migration and labor market analysis. *Source: Extract from the IMF staff report (Federated States of Micronesia) — Section 8.* ### 1.1 percent in FY2025 as factors which drove the rebound in FY2024 dissipate (i.e., jump in fishing output, ### Federated States of Micronesia: Key Macroeconomic Assumptions and Debt Sustainability ### Growth and Inflation outlook - Real GDP growth: - FY2025: 1.1 percent - FY2026: 0.7 percent - FY2027–28: 1.3 percent (2027-28 column shows 1.3 in one series and 1.0 in extended; see table) - Long term: projected to return to 0.7 percent due to structural and capacity constraints including labor shortages - Drivers and near-term dynamics: - FY2024 rebound driven by a jump in fishing output, high bank profitability, and the public sector wage increase; these factors dissipate leading to 1.1 percent in FY2025. - FY2026 moderates to 0.7 percent as real income compression and higher import costs, particularly for the relatively fuel intensive fishing sector, weigh on activity. - Gradual pickup in public investment funded by the Compact of Free Association (COFA) bolsters growth in FY2027 and FY2028, aided by planned project-related grants from MFIs and the Yap airport expansion by the US Department of War. - Inflation: - FY2025: 3.2 percent (eased from 5.4 percent in the previous year) - FY2026: 3.2 percent - FY2027: 4.0 percent (reflecting higher oil and food prices due to the conflict in the Middle East; projections subject to uncertainty) - Long term: projected to fall to 2 percent (converging to US inflation; US dollar is FSM’s legal tender) - The GDP deflator is assumed to move in tandem with inflation. ### Fiscal balance, current account, and public investment - Fiscal balance (percent of GDP): - FY2025: 0.4 - FY2026: 0.4 - FY2027–28: -0.5 (2027) and -3.6 (2028) shown across projection windows; extended medium-term values include -0.4, -1.0, -1.1, -2.5 in later ranges - A fiscal deficit is expected from FY2027 onwards. - Fiscal deterioration drivers: falling fishing fee revenues (climate-change driven decrease in tuna biomass) and accelerating state government spending. - Current account balance (percent of GDP): - FY2025: 3.8 - FY2026: 1.1 - FY2027: -0.6 - FY2028: -1.9 - Long run: projected to shift to a deficit of around 2 percent of GDP due to high public spending despite large grants inflow mainly from the US. - Public investment and grants: - Under the new COFA (effective March 2024), FSM has access to USD 140 million per year (29 percent of GDP in FY2024) in sector grants until FY2043, with an additional USD 500 million in US contributions to the Compact Trust Fund (CTF) in FY2024 and FY2025. - Project-related grants from MFIs increase each year from approximately USD 30 million in FY2026 to a peak of approximately USD 70 million in FY2028 and FY2029 before declining to zero by FY2031 (driven by a jump in planned disbursements from the World Bank). ### Public debt stock and creditor composition (as of Sep-25 / end-FY2025) - Total public debt: 44.5 (In millions of U.S. dollars); 100.0 as a share of total debt; 8.9 in percent of GDP - External: 40.29 (share of total debt 90.3; percent of GDP 8.0) - Multilateral: 32.97 (share 73.8; percent of GDP 6.5) - Asian Development Bank: 31.06 (share 69.7; percent of GDP 6.2) - European Investment Bank: 1.94 (share 4.2; percent of GDP 0.4) - Bilateral: 5.71 (share 12.9; percent of GDP 1.1) - U.S. Department of Agriculture: 5.71 (share 12.9; percent of GDP 1.1) - Commercial: 1.63 (share 3.6; percent of GDP 0.3) - Domestic: 4.39 (share 9.7; percent of GDP 0.9) - Memorandum item: of which: SOE debt 1/ 20.94 (share 47.1; percent of GDP 4.2) - 1/ SOE debt comprises guaranteed ($10.0 million) and on-lent ($10.9 million) debts. - As of end-FY2025: around 70 percent of public debt is owed to the ADB. As this debt is repaid and new concessional borrowing is concentrated in IDA credit, the World Bank is projected to become the largest creditor over the medium term. ### Trust funds, financing mix, and public debt trajectory - FSM Trust Fund (FSMTF) and Compact Trust Fund (CTF) balances: - FSMTF balance at end-FY2025: USD 577 million, or about 115 percent of GDP. - CTF balance at end-FY2025: 395 percent of GDP. - Projected by end of projection period: FSMTF around 146 percent of GDP by end-FY2046; CTF projected to exceed 500 percent of GDP by end of projection period. - FSMTF assumptions and use: - Annual nominal net return rate assumed at 5 percent (same as rate applied to the CTF). - Historical average net return rates: FSMTF 7.6 percent and CTF 7.5 percent as of end-FY2025. - By law, withdrawals from FSMTF are restricted until FY2030; partial drawdown of investment gains to finance fiscal deficits assumed to commence from FY2031 with withdrawals capped to preserve the fund’s real value. - Withdrawals from FSMTF are treated as domestic financing from accumulated assets, not grants. - Financing mix: - New external concessional loans are assumed starting in FY2027 when the fiscal balance is expected to turn into a deficit. - From FY2031, liquid assets, mainly FSMTF drawdowns, are assumed to partially fill gross financing needs (GFNs), with external concessional loans financing the remaining GFNs. - FSM is an IDA-only small state with a moderate risk of debt distress; IDA21 allocation indicative SDR 48.8 million, equivalent to USD 67.1 million as of end-February 2026, with financing on a 50/50 split between grants and credits on Small Economy Terms. ### Debt sustainability and stress-test assessments - Country classification and debt-carrying capacity: - Composite Indicator (CI) index: 1.76 (based on October 2025 WEO and 2024 CPIA). - CI rating: Weak. - Applicable DSA thresholds for FSM: - PV of external debt-to-GDP ratio: 30 percent - PV of external debt-to-exports ratio: 140 percent - External debt service-to-exports ratio: 10 percent - External debt service-to-revenue ratio: 14 percent - PV of public debt-to-GDP ratio: 35 percent - External debt sustainability (baseline and projections): - External debt stock projected to decrease from 8.0 percent of GDP in FY2025 to 6.7 percent in FY2027, then increase to 38.7 percent of GDP in FY2046. - Under the baseline, no breaches in external debt indicators vis-à-vis indicative thresholds over the extended 20-year horizon (through FY2046). - Debt rise after FY2027 driven by decline in fishing fee revenues and increased public investment; large grant inflows from the new COFA keep indicators below thresholds in baseline. - Public sector debt dynamics: - Public debt-to-GDP ratio projected to decrease to 7.3 percent of GDP in FY2027, then increase to 38.7 percent of GDP in FY2046. - PV of the public debt-to-GDP ratio does not breach the benchmark under the baseline through the 20-year projection horizon. - Domestic debt minimal: domestic debt-to-GDP and domestic debt service-to-revenues (including grants) both less than 1 percent in FY2026 and projected to converge to zero around FY2036. - Stress tests and key vulnerabilities: - Standardized DSA stress tests applied: shocks to real GDP growth, the primary fiscal balance, exports, other external flows (transfers and FDI), exchange rate depreciation (not considered because US dollar is legal tender), and combined shock. - Customized natural disaster stress test (added due to severity/frequency of disasters): - One-off shock of 10 percentage points to debt-GDP ratio in FY2027. - Real GDP growth lowered by 9.2 percentage points in the year of the shock. - Exports growth lowered by 13 percentage points in the year of the shock. - Under this natural disaster scenario, PV of external PPG debt-to-GDP and PV of external PPG debt-to-exports are projected to breach thresholds starting in FY2039 and FY2038, respectively. - Other stress test findings: - PV of external PPG debt-to-exports ratio breaches threshold starting in FY2039 if there is an exports shock. - PV of overall debt-to-GDP ratio projected to breach the benchmark in response to a natural disaster shock starting from FY2040 and a growth shock starting from FY2045. - Excluding grants from revenues increases the PV of public-debt-to-revenue ratio and the debt service-to-revenue ratio to 204 percent and 6.6 percent, respectively, in FY2046 when a natural disaster hits. - Risk ratings: - Risk of external debt distress: assessed at moderate (mechanical DSA rating indicates low risk over 10 years, but extended 20-year horizon and stress-test breaches warrant moderate rating). - Risk of overall debt distress: assessed at moderate for similar reasons. ### Policy-relevant implications and projections - Fiscal strategy and financing: - Expectation to rely on a combination of external concessional borrowing and partial drawdown of financial assets (FSMTF) from FY2031 as withdrawals become available. - New borrowing from development partners assumed concessional starting FY2027, given more favorable lending terms relative to domestic loans. - Resilience and contingency: - Large FSMTF and CTF balances provide an additional safeguard for repayment capacity and shock response; baseline assumes cautious capped drawdowns preserving real value. - Natural disaster and export shocks are the principal risks to debt sustainability; stress-test results highlight the need for disaster risk management, fiscal buffers, and prioritization of grant financing where possible. - Medium-term outlook: - Growth remains subdued with structural constraints (labor shortages) limiting potential; inflation elevated in the near term with gradual convergence to 2 percent in the long run. - Current account and fiscal balances are projected to weaken over the medium term, pushing the public debt path higher but remaining within thresholds under baseline assumptions thanks to COFA grants and trust fund buffers. *Source: FSM authorities and IMF staff estimates and calculations.* ### 16. Fiscal risks from SOEs are mainly concentrated in state utility corporations. Part of SOE’s weak ### 16. Fiscal risks from SOEs are mainly concentrated in state utility corporations. Part of SOE’s weak ### Fiscal risks from state-owned enterprises (SOEs) - Budgeted transfers from the national government to SOEs in FY2026 amount to USD 0.3 million, allocated entirely to Caroline Islands Air. - Pohnpei State Government provided USD 0.8 million to the Pohnpei Utilities Corporation (PUC) in FY2023; PUC is a beneficiary of state guarantees on loans from the ADB. - The national government withheld approximately USD 0.6 million of Pohnpei State’s revenue shares in FY2023 to meet PUC’s past debt service shortfalls. - The Yap State Government paid USD 0.8 million in FY2023 to cover the principal and interest of the ADB loan owed by the Yap State Public Service Corporation. - These transfers range from 0.1 to 0.2 percent of GDP and are recurrent; some SOEs continue to exhibit weak operating performance, including operating losses even after support, implying persistent fiscal risks. ### Climate change adaptation needs and fiscal implications - FSM’s annual adaptation costs are estimated at one-third of the FSM’s GDP. - There are over 60 WWII-era shipwrecks with potential oil-spill costs; the cost of extracting oil from each wreck is estimated at 2-7 percent of GDP. - A national emergency was declared in late September 2025 following a significant leak. - The DIGNAD model analysis indicates that greater preemptive public investment in climate-resilient infrastructure can substantially reduce macroeconomic costs from natural disasters and improve long-term debt sustainability, irrespective of the financing strategy employed. - Financing the entirety of adaptation needs without sufficient grant and concessional support would jeopardize debt sustainability, particularly given the limited capacity of the private sector. - Policy implication: scale up resilient investment while preserving debt sustainability through an appropriate combination of grants, concessional financing, and strengthened domestic revenue mobilization. ### Macroeconomic data gaps and statistical timelines - Balance of Payments and GDP statistics are available until FY2023. - Complete debt data is available up to December 2024. - Debt data as of end-FY2025 is estimated based on partial data provided by the authorities and the debt repayment schedule in the national government’s financial reports. - Authorities are working to close data gaps by: - Improving interdepartmental data sharing with support from PFTAC. - Reviewing the national accounts methodology in collaboration with development partners. - Leveraging newly launched systems: ASYCUDA (automated systems for customs data), the revenue management system (RMS), and the financial management information system (FMIS) to enhance timeliness and coverage. ### Public financial management and debt management recommendations - Establish a medium-term fiscal framework to guide budgets toward long-term goals and promote fiscal discipline and sustainability. - Enhance capacity to plan and implement public spending for effective public investment implementation. - Strengthen debt management by: - Regularly publishing a debt bulletin to improve transparency and accountability. - Over time developing a medium-term debt strategy. - Ensuring new borrowing remains concessional and well-targeted. - Prioritize climate-resilient infrastructure investments to reduce disaster-related economic losses and enable faster recovery (see Annex VII of the 2026 Article IV). - For FSM, pursue early and targeted adaptation investments supported by grants, concessional financing, and potential tax reforms to protect fiscal space and improve long-term debt sustainability. ### Authorities' views - Authorities broadly concurred with staff’s assessment of the overall risk of debt distress, with caveats regarding the risk rating. - They noted that the customized stress test reflects only a natural disaster shock and does not reflect slow-moving effects of climate change (e.g., rising temperature and drought), and hence underestimates the impact of climate change on the economy and debt sustainability. - Authorities expressed concerns about treating trust funds as an additional safeguard for debt sustainability, given that trust funds also serve to ensure intergenerational equity. - They acknowledged the need to contract new concessional loans to finance development needs but emphasized proceeding prudently due to concerns about repayment capacity. - While noting the national government can withhold tax revenue transfers to states that do not meet debt obligations, authorities stressed that such measures may constrain states’ ability to provide essential public services. *Source: IMF staff report text (section provided).* ### 2.5 percentage points of GDP in ### 2.5 percentage points of GDP in ### Indicators of Domestic Debt, 2021-2036 - Domestic Debt-to-GDP Ratio (Median projected values, end-2023 basis): series shown from 2021 to 2035 with values up to "20" on chart scale. - Domestic Debt Service to Revenues incl. Grants: charted up to "25" percent (scale points shown: 0, 5, 10, 15, 20, 25). - Net Domestic Debt Issuance (Value): chart scale from -150.0 to 150.0 and -0.6 to 1.0 depicted for different measures. - Medium and long-term borrowing assumptions (average over 10-year projection) include: - Shares in new domestic debt issuance: Domestic short-term debt; Domestic MLT debt. - Avg. real interest rate (short-term and MLT) and borrowing terms: Avg. maturity (incl. grace period) and Avg. grace period shown as chart items (no numeric table provided in source excerpt). ### External Debt Sustainability Framework, Baseline Scenario, 2025-2046 (selected indicators) - External debt (nominal) 2025–2046 (in percent of GDP): 8.0, 6.7, 6.7, 7.2, 8.0, 8.8, 9.3, 13.9, 38.7, 16.5, 9.6 (series labeled 2025–2046, row headed "External debt (nominal) 1/"). - Change in external debt: -1.4, -1.3, 0.0, 0.5, 0.7, 0.8, 0.6, 1.2, 3.5 (series aligned with projection years). - Identified net debt-creating flows: -4.1, -1.1, 0.4, 0.7, 1.1, 1.1, 1.0, 1.2, 3.7, -13.3, 0.7. - Non-interest current account deficit: -3.9, -1.2, 0.3, 0.7, 1.1, 1.0, 0.9, 1.1, 3.6, -13.0, 0.7. - Deficit in balance of goods and services (percent of GDP): 49.0, 51.8, 54.3, 55.5, 55.3, 52.9, 51.4, 47.5, 43.2, 44.7, 51.1. - Exports (percent of GDP): 22.1, 21.6, 21.3, 21.2, 20.8, 20.7, 20.7, 20.7, 20.7. - Imports (percent of GDP): 71.0, 73.4, 75.6, 76.7, 76.1, 73.6, 72.1, 68.2, 63.8. - Net current transfers (negative = inflow): -42.4, -42.4, -44.0, -45.2, -45.0, -42.8, -41.7, -38.6, -33.1, -45.9, -41.5. - Of which: official transfers: -30.6, -30.8, -32.4, -33.6, -33.3, -31.1, -29.9, -26.8, -21.1. - Endogenous debt dynamics: -0.2, 0.1, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, 0.0. - Contribution from nominal interest rate: 0.2, 0.1, 0.1, 0.1, 0.1, 0.1, 0.1, 0.1, 0.3. - Contribution from real GDP growth: -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.2. - Contribution from price and exchange rate changes: -0.3 (followed by ellipsis in source). - Residual: 2.7, -0.2, -0.4, -0.2, -0.4, -0.3, -0.4, 0.0, -0.2, 11.5, -0.2. - Sustainability indicators: - PV of PPG external debt-to-GDP ratio: 6.6, 5.5, 5.0, 4.8, 4.8, 4.8, 4.9, 6.5, 19.0. - PV of PPG external debt-to-exports ratio: 29.8, 25.6, 23.4, 22.7, 23.0, 23.2, 23.5, 31.7, 92.1. - PPG debt service-to-exports ratio: 5.3, 5.1, 5.1, 4.2, 3.8, 3.7, 2.7, 1.5, 2.4. - PPG debt service-to-revenue ratio: 3.6, 3.4, 3.4, 2.8, 2.5, 2.5, 1.9, 1.1, 1.9. - Gross external financing need (Million of U.S. dollars): -13.5, -0.4, 7.8, 8.9, 11.0, 10.9, 9.2, 10.2, 37.7 (series across years shown). - Key macroeconomic assumptions: - Real GDP growth (in percent): 1.1, 0.7, 1.1, 1.4, 1.0, 0.7, 0.7, 0.7, 0.7, 1.0, 0.8. - GDP deflator in US dollar terms (change in percent): 3.2, 3.2, 4.0, 1.7, 2.0, 2.0, 2.0, 2.0, 2.0, 4.0, 2.3. - Effective interest rate (percent) 4/: 1.8, 1.7, 1.6, 1.3, 1.2, 1.0, 1.0, 0.8, 0.8, 2.4, 1.1. - Growth of exports of G&S (US dollar terms, in percent): 2.7, 1.7, 3.7, 2.6, 1.1, 2.4, 2.6, 2.7, 2.7, 5.4, 2.5. - Growth of imports of G&S (US dollar terms, in percent): 0.2, 7.4, 8.3, 4.6, 2.3, -0.7, 0.5, 2.3, 2.7, 4.1, 2.7. - Grant element of new public sector borrowing (in percent): 59.4, 59.4, 59.4, 59.4, 59.4, 59.4, 57.4, ... , 59.4 (ellipses indicate incomplete series in excerpt). - Fiscal and aid parameters: - Government revenues (excluding grants, in percent of GDP): 32.9, 32.4, 31.9, 31.3, 30.9, 30.5, 30.2, 28.6, 25.9, 40.8, 30.3. - Aid flows (in Million of US dollars) 5/: 139.0, 156.0, 197.7, 223.3, 232.6, 215.2, 204.5, 198.4, 238.2. - Grant-equivalent financing (in percent of GDP) 6/: 35.5, 38.9, 39.3, 35.3, 32.8, 27.6, 24.1, ... , 32.3 (series incomplete in excerpt). - Grant-equivalent financing (in percent of external financing) 6/: 98.5, 98.5, 98.5, 98.3, 98.2, 97.5, 92.5, ... , 98.1. - Nominal GDP (Million of US dollars): 502, 521, 548, 565, 583, 598, 614, 702, 917 (series shown as memorandum). - Nominal dollar GDP growth: 4.3, 3.9, 5.2, 3.1, 3.1, 2.7, 2.7, 2.7, 2.7, 5.0, 3.1. - PV of external debt (memorandum): 6.6, 5.5, 5.0, 4.8, 4.8, 4.8, 4.9, 6.5, 19.0. - PV of PPG external debt (in Million of US dollars): 33.0, 28.9, 27.3, 27.2, 27.8, 28.8, 29.9, 45.9, 174.6. - (PVt-PVt-1)/GDPt-1 (in percent): -0.8, -0.3, 0.0, 0.1, 0.2, 0.2, 0.7, 2.4. - Non-interest current account deficit that stabilizes debt ratio: -2.5, 0.0, 0.3, 0.2, 0.4, 0.2, 0.3, -0.1, 0.1. ### Public Sector Debt Sustainability Framework, Baseline Scenario, 2025-2046 (selected indicators) - Public sector debt (percent of GDP): 8.9, 7.5, 7.3, 7.7, 8.4, 9.1, 9.5, 13.9, 38.7, 17.2, 9.9. - Of which: external debt: 8.0, 6.7, 6.7, 7.2, 8.0, 8.8, 9.3, 13.9, 38.7, 16.5, 9.6. - Change in public sector debt: -1.5, -1.4, -0.1, 0.4, 0.6, 0.7, 0.5, 1.2, 3.5. - Identified debt-creating flows: -0.8, -0.7, -0.1, 0.4, 0.6, 0.7, 0.5, 1.2, 3.5, -9.9, 0.5. - Primary deficit: -0.6, -0.6, 0.1, 0.5, 0.7, 0.8, 1.1, 2.5, 7.1, -9.5, 1.1. - Revenue and grants (percent of GDP): 60.6, 62.4, 66.6, 69.3, 69.3, 64.8, 62.2, 55.2, 47.4, 70.5, 61.6. - Of which: grants: 27.7, 29.9, 34.7, 38.0, 38.3, 34.3, 32.0, 26.5, 21.5. - Primary (noninterest) expenditure (percent of GDP): 60.0, 61.8, 66.8, 69.8, 69.9, 65.6, 63.3, 57.7, 54.5, 61.0, 62.7. - Automatic debt dynamics: -0.2, -0.1, -0.2, -0.1, -0.1, -0.1, -0.1, -0.2, -0.6. - Contribution from interest rate/growth differential: -0.2, -0.1, -0.2, -0.1, -0.1, -0.1, -0.1, -0.2, -0.6. - Contribution from average real interest rate: -0.1, -0.1, -0.1, 0.0, 0.0, 0.0, -0.1, -0.1, -0.4. - Contribution from real GDP growth: -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.1, -0.2. - Other identified debt-creating flows: 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, -0.5, -1.1, -3.0, 0.0, -0.4. - Other debt creating or reducing flow 2/: 0.0, 0.0, 0.0, 0.0, 0.0, 0.0, -0.5, -1.1, -3.0. - Residual 3/: -0.7, -0.7, -0.1, 0.0, 0.0, 0.0, 0.0, 0.0, 8.2, -0.1. - Note: "The residuals are high in 2025 and 2026 because the fiscal surplus is assumed to be deposited into the government account." - Sustainability indicators: - PV of public debt-to-GDP ratio 4/: 7.4, 6.3, 5.6, 5.3, 5.2, 5.1, 5.1, 6.5, 19.0. - PV of public debt-to-revenue and grants ratio: 12.3, 10.1, 8.4, 7.7, 7.5, 7.9, 8.2, 11.9, 40.2. - Debt service-to-revenue and grants ratio 5/: 2.1, 2.0, 1.8, 1.4, 1.3, 1.3, 1.1, 0.6, 1.0. - Gross financing need 6/: 0.7, 0.7, 1.3, 1.5, 1.6, 1.7, 1.3, 1.7, 4.6. - Key macro and fiscal assumptions: - Real GDP growth (in percent): 1.1, 0.7, 1.1, 1.4, 1.0, 0.7, 0.7, 0.7, 0.7, 1.0, 0.8. - Average nominal interest rate on external debt (in percent): 1.8, 1.7, 1.6, 1.3, 1.2, 1.0, 1.0, 0.8, 0.8, 2.4, 1.1. - Average real interest rate on domestic debt (in percent): -1.1, -0.8, -1.3, 1.4, 1.6, 2.3, 3.5, 2.9, 2.9, -1.2, 2.4. - Inflation rate (GDP deflator, in percent): 3.2, 3.2, 4.0, 1.7, 2.0, 2.0, 2.0, 2.0, 2.0, 4.0, 2.3. - Growth of real primary spending (deflated by GDP deflator, in percent): 1.8, 3.6, 9.2, 6.0, 1.2, -5.5, -2.9, 0.2, 0.0, 2.0, 0.5. - Primary deficit that stabilizes the debt-to-GDP ratio 7/: 1.0, 0.8, 0.2, 0.1, 0.1, 0.1, 0.6, 1.3, 3.7, 1.8, 0.7. - PV of contingent liabilities (not included in public sector debt): 0.0 across series shown. ### Qualification of the Moderate Category, 2026-2046 (selected chart indicators) - Debt Service-to-Revenue Ratio, PV of Debt-to-GDP Ratio, PV of Debt-to-Exports Ratio, Debt Service-to-Exports Ratio: charted over 2026–2046 with category bands "Some space", "Substantial space", "Limited space", "Threshold", and "Baseline" indicated. (Threshold definitions given: For the PV debt/GDP and PV debt/exports thresholds, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent.) ### Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2026-2046 (selected rows) - Baseline (row): 65, 55, 55, 55, 56, 67, 19 (first series across years 2026–2046). - Alternative Scenarios: - A1. Key variables at their historical averages in 2026-2036 2/: 60, 0, 0, 0, 0, 0, 0, 0, 0, 0, 0. - A2. Alternative Scenario: Natural disaster: 61, 11, 21, 24, 15, 17, 18, 20, 22, 24, 26, 51 (series across years). - Bound Tests: - B1. Real GDP growth: 65, 55, 55, 56, 66, 67, 21. - B2. Primary balance: 69, 12, 12, 13, 13, 13, 13, 14, 14, 15, 27. - B3. Exports: 68, 12, 12, 12, 12, 13, 13, 14, 14, 15, 26. - B4. Other flows 3/: 67, 9, 9, 9, 9, 10, 10, 10, 11, 12, 2. - B5. Depreciation: 65, 55, 55, 55, 56, 67, 19. - B6. Combination of B1-B5: 68, 88, 99, 99, 101, 101, 101, 101, 123. - Tailored Tests: - C1. Combined contingent liabilities: 67, 77, 77, 77, 88, 88, 92, 2. - C2–C4: n.a. (not applicable / not available) for Natural disaster, Commodity price, Market Financing in this excerpt. - Thresholds and alternate indicator blocks: - Threshold lines: 30; 14; and other threshold rows included in the table for comparative purposes. - Alternate baseline block (second set): Baseline 26, 23, 23, 23, 23, 24, 24, 25, 27, 29, 32, 92 (series shown). - Alternative Scenarios (second block): - A1. Key variables at their historical averages in 2026-2036 2/: 26, 0, 0, 0, 0, 0, 0, 0, 0, 0, 0, 0. - A2. Natural disaster: 26, 54, 60, 68, 76, 83, 91, 99, 109, 118, 128, 257. - Additional bound tests and tailored tests series follow in table rows with numeric outcomes across 2026–2046 for different indicators (full matrix shown in source excerpt). *Source: Federated States of Micronesia — IMF staff estimates and projections, figures and tables as provided in the source PDF excerpt.* ### 2. Alternative Scenario :Natural disaster565554443339 ### 2. Alternative Scenario :Natural disaster ### Alternative scenario and recent shock events - A tropical typhoon disrupted livelihoods and infrastructure in the Chuuk island of FSM in April 2026, placing additional strain on already limited fiscal and implementation capacity. - The clean-up and containment cost of the recent oil spillage from WWII shipwrecks in the Chuuk area are assessed to be substantial; there are about sixty shipwrecks in the area. - Global developments—most notably the Middle East conflict—are likely to contribute to higher fuel and imported food prices, exacerbating inflationary pressures in a highly import-dependent economy and increasing the cost of service delivery and disaster mitigation efforts. - The shocks reinforce the urgency of strengthening resilience to external and climate-related risks. ### Recent economic developments, outlook, and risks - Growth and inflation - Economic growth moderated to 1.1 percent in FY2025 from 2.3 percent in FY2024. - Inflation eased from 5.4 percent in FY2024 to 3.2 percent in FY2025. - Growth is expected to moderate further to 0.7 percent in FY2026. - In FY2027 – FY2028, growth is anticipated to temporarily strengthen, supported by higher external grants including COFA-funded public investment, expansion of Yap airport, and housing construction for foreign workers. - Over the medium term, growth is projected to remain subdued at around 0.7 percent. - External and fiscal balances - The fiscal surplus narrowed from 1.7 percent of GDP in FY2024 to 0.4 percent of GDP in FY2025, mainly reflecting lower fishing revenues. - The current account surplus increased slightly to 3.8 percent of GDP, supported by a reduced trade deficit and higher corporate income tax inflows which more than offset the decline in fishing revenues. - The fiscal balance and current account are projected to be in deficit over the medium term as the government resorts to external concessional borrowing to support increased development spending and as fishing revenue declines due to climate change effects. - Downside and upside risks - Downside risks: delays in infrastructure implementation; ongoing emigration and skills shortages; weaker-than-expected fishing revenues; climate-related disruptions to food production; more frequent natural disasters; potential large unspent COFA grants due to limited implementation capacity; costs from oil spillage; elevated oil prices from geopolitical tensions. - Upside risks: effective reform implementation that could unlock private sector activity, generate employment, and reduce dependence on external aid. ### Fiscal policy stance and public investment management - Policy priorities and reforms - Authorities remain committed to maintaining prudent fiscal management while addressing substantial development and climate-related spending needs. - The increase in COFA grants will support priority investments in infrastructure and build resilience, while placing public debt on a sustainable path. - Authorities are advancing tax reforms, including the introduction of a VAT and a net profits tax, to enhance domestic revenue mobilization and support private sector development. - Public financial management and capacity building - Efforts underway to strengthen public financial management include rollout of digital revenue and expenditure systems. - Implementations: automated system for customs data, the revenue management system, and partial rollout of the financial management information system. - The Infrastructure Development Plan (IDP) 2025-2034 was approved and presents a 10-year roadmap for FSM’s capital development needs. - With fishing revenues now shared with the states, national authorities have reallocated resources by reducing transfers to the FSM Trust Fund and scaling back congressional projects; emphasis on strengthening state-level planning and implementation capacity. - Financing and sustainability - Continued support from the IMF and development partners will be critical to improving public investment management, integrating climate change into infrastructure planning, strengthening medium-term fiscal frameworks, and building debt management capacity across all government levels. - Authorities emphasize preserving financial resources in the trust fund for future generations. ### Financial sector resilience and reforms - Banking sector - The banking sector remains broadly sound, supported by strong capital and liquidity buffers. - Non-performing loans have increased, but systemic risks remain contained due to limited macro-financial linkages and low levels of domestic lending. - Regulatory and institutional measures - Authorities have enhanced regulatory and supervisory frameworks through the FSM Banking Board, including efforts to expand its mandate to cover non-bank financial institutions such as the FSM Development Bank and credit unions. - Measures to improve risk management and monitor rising non-performing loans are ongoing. - Financial inclusion and development - Promotion of digital financial services—including digital payments and banking platforms—to improve financial inclusion and generate better financial data to support lending decisions. - Progress in strengthening the FSM Development Bank’s operations, including loan restructuring and accreditation with international climate financing institutions to expand access to funding. - Continued technical assistance from the IMF and development partners supports supervision, financial inclusion, and financial deepening objectives. ### Structural reforms and constraints - Reform agenda - Structural reforms advanced under the Strategic Development Plan 2024-2043 (SDP) focus on private sector development and economic diversification. - Ongoing efforts to improve the business environment, streamline regulations across states, and expand digitalization. - Constraints to implementation - Key constraints: land tenure issues limiting investment; complicated governance structure making it difficult to gain state-level support; limited financial and institutional capacity. - Reforms in education and formal sector job creation are critical to address emigration but require broad consensus and adequate resources. - Continued support from development partners is essential to strengthen institutional capacity, build human capital, and unlock private sector potential. ### Climate change, disaster risk management, and resilience building - Policy commitments and planning - Authorities are developing the National Adaptation Plan and have committed under NDC 3.0 to ambitious mitigation and adaptation targets, including achieving net-zero emissions by 2050, scaling up renewable energy, and strengthening climate resilience and food security. - Disaster risk financing and institutional measures - Participation in regional risk financing mechanisms such as the Pacific Catastrophe Risk Insurance Company and strengthening the Disaster Assistance Emergency Fund to provide timely response to shocks. - Efforts to integrate climate resilience into public investment planning and promote climate-smart agriculture through donor-supported research into resilient crops for vulnerable atoll and coastal communities. - Work to improve coordination and institutional frameworks to better access climate finance and operationalize resilience-building projects, including accreditation of national institutions to channel financing for adaptation initiatives. - Implementation challenges - Despite progress, spending requirements remain substantial and implementation of adaptation initiatives is complex, hindering progress. - Continued external support from the IMF and development partners will be key to mobilize climate finance, build resilience, and safeguard long-term development outcomes. ### Sensitivity analysis note - Table 4 provides a sensitivity analysis for key indicators of public debt for 2026-2046, including scenario testing (A1, A2), bound tests (B1–B6), and tailored tests (C1–C4). The table and accompanying notes identify which variables are included in scenarios and which tests are not applicable (n.a.). Sources for the sensitivity analysis are country authorities and staff estimates and projections. *Prepared by Asia and Pacific Department (In consultation with other departments); sources: country authorities; and staff estimates and projections.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2026/english/1fsmea2026001-source-pdf.pdf_