## _cr11293

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---

### Background and program context
- In 2009 the Government of Maldives implemented a comprehensive adjustment program supported by the Fund to address severe fiscal and external imbalances driven by an unsustainable increase in public spending after the 2004 tsunami and by the global crisis.
- Program (approved December 2009) centered on:
  - strong fiscal adjustment to restore medium-term sustainability;
  - monetary tightening and cessation of deficit monetization;
  - measures to strengthen the banking sector.
- Implementation slippages: delays in key tax reforms; earlier-than-envisaged restoration of wages; lack of progress on public employment restructuring.
- Political environment: deep polarization and strained executive–parliament relations; local island-level elections scheduled for February 2011 could delay reforms.

### Recent economic developments
- Output and tourism:
  - Real GDP contracted by 2¼ percent in 2009.
  - Real GDP growth is projected at 4¾ percent in 2010.
  - Tourism recovery by November 2010: tourist arrivals up 20 percent y/y and bednights up 18½ percent y/y.
  - Spending per tourist per day reported to have fallen; fishing sector continues secular decline.
- Inflation:
  - Inflation projected at an average of 5 percent in 2010, driven by international commodity prices and local fish prices.
- Monetary and financial sector:
  - Reserve money fell through September 2010 but rose sharply after end-October due to a large increase in foreign currency deposits associated with airport privatization parent funding.
  - Broad money is expected to increase by 16¾ percent in 2010.
  - Private sector credit has stalled; bank purchases of T-bills have pushed up overall credit.
  - Banking sector vulnerabilities:
    - Banks’ gross claims on government represent 18 percent of assets and 28 percent of loans.
    - Bank of Maldives (BML) has very large non-performing loans and faces dollar liquidity stresses.
- External sector:
  - Current account deficit is expected to have increased to about 32¼ percent of GDP in 2010.
  - International reserves fell from $150 million in April 2010 to $87 million by end-October 2010, then were boosted by airport privatization proceeds of $74 million in November 2010.
  - Parallel market premium increased to around 10 percent.
  - Real effective exchange rate (REER) has appreciated since mid-2008.
- Fiscal sector:
  - Preliminary revenue and expenditure data point to under-execution of the budget and a 2010 fiscal deficit close to the program target of 17¾ percent of GDP; financing data indicate a deficit of around 20¼ percent of GDP.
  - Debt revised down relative to initial projections due to larger-than-expected privatization inflows (estimated at about $97 million in 2010) and better information on SOE-guaranteed debt.

### Growth, competitiveness, and medium-term outlook
- Long-run growth prerequisites:
  - Macroeconomic stability and structural reforms: education, infrastructure, ease of doing business.
  - Tourism to remain engine of growth; diversification into other industries, including services such as outsourcing, required.
- Exchange rate and competitiveness:
  - CGER-type analysis indicates a significant real exchange rate overvaluation on current policies.
  - Significant fiscal consolidation, possibly with a nominal devaluation, would be needed to bring the REER to a sustainable path.
- Medium-term projections and risks:
  - Gradual growth recovery expected with rates around 4½ percent over the medium term.
  - On current policies the current account deficit would remain high, potentially leading to reserve depletion and an external financing gap.
  - Domestic risks tilted to the downside: slow fiscal consolidation, persistent external imbalances and dollar shortages, political tensions.

### Fiscal policy — recent measures, slippages, and quantified deviations
- Key slippages and policy changes:
  - T-GST passed in August 2010 at 3½ percent instead of 4 percent; parallel bill maintained the $8 bed tax through end-2013.
  - Business profit tax (BPT) passed in December 2010 to enter into effect July 2011, eighteen months later than planned.
  - Implementation of the general GST delayed due to administrative capacity constraints.
  - Wages restored to September 2009 levels from January 2011 (one year earlier than programmed).
  - New Decentralization and Disability Bills will increase spending.
- Staff estimates of deviations from program projections (Deviations from program projections, in percent of GDP):
  - Revenue and grants: 2010 -0.8; 2011 -3.3; 2012 -0.8
  - SOE transfers: 2010 2.8; 2011 0.8; 2012 0.7
  - Delay of, and base revisions for BPT: 2010 -1.6; 2011 -1.6; 2012 -0.3
  - Changes associated with implementation of T-GST (net): 2010 -3.9; 2011 -1.6; 2012 0.4
    - delay in entry into effect: 2010 -1.1; 2011 0.0; 2012 0.0
    - change in rate from 4 percent to 3.5 percent: 2010 0.0; 2011 -0.6; 2012 -0.7
    - proposed changes to resort lease payment regime: 2010 -2.8; 2011 -1.7; 2012 0.4
  - Revised timetable for implementation of the general GST: 2010 0.0; 2011 -2.2; 2012 -2.9
  - Other (net): 2010 0.8; 2011 -1.8; 2012 -1.7
- Expenditure deviations (selected, in percent of GDP):
  - Pensions (7% employee contribution taken on by govt): 2010 0.5; 2011 0.0; 2012 0.0
  - Salaries and wages: 2010 1.4; 2011 6.2; 2012 4.1
  - Limited progress on redundancies: 2010 2.5; 2011 2.4; 2012 2.3
  - Restoration of wages: 2010 -1.1; 2011 2.8; 2012 0.7
  - Employment associated with Decentralization Bill: 2010 0.0; 2011 1.0; 2012 1.1
  - Social welfare contributions: 2010 -0.8; 2011 2.6; 2012 3.1
    - disability benefits (2011q1~): 2010 0.0; 2011 1.4; 2012 1.4
  - Capital expenditure: 2010 -0.4; 2011 5.1; 2012 6.8
  - Total increase in fiscal deficit relative to program targets: 2010 0.4; 2011 17.2; 2012 15.3

### Comparison: 2011 Budget vs IMF Baseline (Millions of rufiyaa; percent of GDP where indicated)
- Revenue and grants: Budget 8,874; IMF Baseline 8,136; Difference -3.6
- Business profit tax: Budget 613; IMF Baseline 260; Difference -1.7
- Administrative fees and charges 2/: Budget 1,184; IMF Baseline 684; Difference -2.4
- Other revenue: Budget 4,703; IMF Baseline 4,723; Difference 0.1
- Expenditure and net lending: Budget 12,164; IMF Baseline 12,549; Difference 1.9
- Disability Act cost: Budget 108; IMF Baseline 28; Difference 0.8
- Interest payments: Budget 601; IMF Baseline 768; Difference 0.8
- Other expenditure: Budget 3,135; IMF Baseline 3,135; Difference 0.0
- Overall balance: Budget -3,290; IMF Baseline -4,413; Difference -5.4
- Nominal GDP 1/: Budget 20,656; IMF Baseline 20,656
- Note: The budget included Rf 500 mn of proceeds from land sales.

### Policy priorities and staff recommendations
- Fiscal:
  - Implement outstanding fiscal adjustment measures and adopt additional consolidation to restore sustainability.
  - Submit additional revenue measures to the Majlis as a package, including excises on alcohol, tobacco, jet fuel, gasoline, and vehicles (to come into effect in July 2011).
  - Continue preparing for T-GST, BPT, and G-GST at a rate of 6 percent in January 2013.
  - Passage of a provision so T-GST rate rises to 6 percent when the bed tax is eliminated at end-2013.
- Expenditure-side recommendations:
  - Implement a realistic redundancy program to achieve a net reduction of around 2,000 central government jobs by end-2011 and a further 2,000 by end-2012; baseline redundancy package assumes six months of salary.
  - Preserve welfare spending for the poor by improving targeting; continue replacing subsidies with targeted transfers.
  - Cut 2011 capital expenditures by 2½ percent of GDP (relative to the budget) to 10 percent of GDP; limit operating expenditure growth in 2011 to CPI inflation (implying savings of 1¼ percent of GDP in 2011 relative to the budget).
- Monetary and exchange rate:
  - Maintain monetary tightening and avoid deficit monetization.
  - Consider a significant exchange rate adjustment (nominal devaluation) alongside fiscal consolidation and wage restraint to correct REER overvaluation.
- Financial sector:
  - Enforce prudential regulations: single borrower limits, asset classification and provisioning, foreign currency exposure limits by end-2011.
  - Regular stress testing (interest rate, exchange rate, NPLs) and a crisis preparedness and management strategy.
  - Recapitalize Bank of Maldives (BML); conduct independent diagnostic audit; strengthen management.
- Public financial management:
  - Expedite PEFA assessment recommendations; migrate foreign-financed expenditure data to public accounts; improve budget preparation and move to medium-term budgeting; adopt a fiscal responsibility framework; generate monthly fiscal outturn reports; create a policy unit at the Ministry of Finance and Treasury.

### The 2011 budget stance, financing needs, and risks
- Budget features:
  - 2011 budget provides for a 21 percent increase in government spending relative to preliminary 2010 data.
  - Capital expenditure in the 2011 budget increases by 37 percent.
  - Budget projects a fiscal deficit of 16 percent of GDP, but staff adjustments raise this to 21¼ percent of GDP, a 3½ percent of GDP expansion compared with 2010.
- Staff baseline projections:
  - Fiscal deficit at 19 percent of GDP in 2012.
  - Debt reaching 135 percent of GDP in 2015 and over 300 percent by 2030.
  - Risk of debt distress increased from moderate to high.
- Financing needs and risks:
  - Outstanding stock of T-bills was over Rf 4 bn (21 percent of GDP) by end-2010, most with maturities of three months or under.
  - Government gross financing needs in 2011 are estimated at 45½ percent of GDP.
  - Privatization and land sales in 2011 include US$154 million (9½ percent of GDP) from land sales and divestment of the telecoms company.
  - Expiration of lease extension payments from 2013 and elimination of the $8 bed tax would cause the fiscal deficit to balloon from 2014.

### Quantified fiscal impact of additional adjustment measures (In percent of GDP)
- Total: 2011 = 6.6; 2012 = 10.9
- Excises on gasoline and jet fuel (2011q3~): 2011 = 0.8; 2012 = 1.4
- Excises on alcohol and tobacco (2011q3~): 2011 = 1.1; 2012 = 2.0
- Excises on vehicles and parts (2011q3~): 2011 = 0.6; 2012 = 1.1
- Redundancy program 1/: 2011 = 0.5; 2012 = 2.4
- Cuts in non-wage, non-interest operating expenditures 1/: 2011 = 1.3; 2012 = 0.0
- Cuts in capital expenditures 1/: 2011 = 2.4; 2012 = 4.0
- An adjustment scenario reflecting all these measures projects the fiscal deficit would fall to 8 percent of GDP in 2012 and 5½ percent by 2015.
- Staff caveat: Even with these measures, debt-to-GDP would remain about current levels through 2015 and fall very slowly thereafter; vulnerability to shocks would remain.

### Monetary and exchange rate policy considerations
- Exchange rate options and trade-offs:
  - Step devaluation: would need to be large (of the order of 20–30 percent) and supported by credible fiscal consolidation; risks include speculative runs.
  - Float/managed float: avoids using reserves to defend peg; shallow domestic markets imply high volatility; managed float preferred to pure float to reduce volatility.
- MMA policy actions:
  - Continue tightening monetary policy to rein in broad money and reduce currency pressures.
  - Increase frequency of open market operations; introduce two-week reverse repos beginning February 14; consider increasing minimum reserve requirement (currently at 25 percent).
- Pass-through and fiscal gains:
  - Appendix 1: If nominal wages remain constant, a 25 percent nominal depreciation could improve the fiscal balance by about 3½ percent of GDP relative to the baseline.
  - If government wages are indexed to CPI inflation, the net fiscal impact from devaluation would become negative.

### Financial sector: vulnerabilities and reforms
- System conditions:
  - Aggregate capitalization appears adequate but asset quality deteriorated due to exposure to tourism-related borrowers.
  - Banks long in dollars; devaluation would directly benefit banks; negative impact on dollar loans to non-dollar earners likely small.
- Regulatory and supervisory actions:
  - Enactment of the Banking Act.
  - MMA implementing safeguards: appointment of an international external auditor firm; audited statements published; steps toward adopting IFRS.
  - IMF assessing Maldives’ AML/CFT framework; onsite mission in October 2010 found significant shortcomings.

### Program performance and external financing
- All performance criteria for March and June 2010 were met, as were indicative targets for September 2010.
- December 2010 IT for reserve money was breached; preliminary information suggests the fiscal deficit financing IT was breached by a very large margin.
- For 2011, total external financing requirements are projected to increase to $933 million.
- Continued delays in completion of the Fund program review could trigger suspension of financing from the World Bank and the Asian Development Bank, leading to a total fall in multilateral financing of $73 million in 2011.

### Debt trends, DSA results, and vulnerabilities
- Public debt trends:
  - Total public debt rose from 55 percent of GDP in 2004 to an estimated 89 percent of GDP in 2010.
  - Total PPG debt by year (percent of GDP): 2004: 55.2; 2005: 64.9; 2006: 62.9; 2007: 66.3; 2008: 68.6; 2009: 85.6; 2010: 88.7.
  - PPG external (percent of GDP): 2004: 40.1; 2005: 41.3; 2006: 39.6; 2007: 39.8; 2008: 37.4; 2009: 41.8; 2010: 41.8.
  - PPG domestic (percent of GDP): 2004: 15.1; 2005: 23.6; 2006: 23.4; 2007: 26.4; 2008: 31.2; 2009: 43.9; 2010: 46.9.
- Debt sustainability (DSA) key outcomes:
  - Baseline: PV of public debt-to-GDP projected to rise from 88 percent in 2010 to 306 percent by 2030.
  - Baseline: PPG external debt worsens through 2030, breaching external debt stock burden thresholds; PV of external debt to GDP breaches its threshold in 2010.
  - Baseline macro assumptions (selected):
    - Real GDP growth: projected average 4.4 percent a year in 2010–15; growth was -2.3 percent in 2009.
    - Inflation: projected around 4 percent a year in 2010–15.
    - Interest rates on public debt: assumed to increase to 7.3 percent by 2016 and remain at that level thereafter.
    - External current account deficit (including grants): projected to average about 36.4 percent of GDP per year in 2010–15 and to rise to about 55 percent of GDP in 2030.
    - Gross reserves: assumed fully depleted by 2013 under the baseline; become negative thereafter, implying an unmet financing gap cumulatively reaching 131 percent of GDP by 2030.
  - Stress tests:
    - Combination shock (one standard deviation to growth, exports, GDP deflator, non-debt flows) has largest short-term impact.
    - Interest rate shock (2 percentage points increase on new borrowing) has largest long-term impact.
    - Export shock yields most extreme impact on debt-to-exports and debt service-to-exports ratios.
- Policy implication from DSA:
  - Current policies would lead to extremely large domestic and external financing requirements that cannot realistically be met; calls for additional fiscal consolidation measures in the near term.

### Appendix 1 — Fiscal impact of a 25 percent devaluation (selected figures)
- Main finding:
  - If nominal wages remain constant, a 25 percent nominal depreciation could improve the fiscal balance by about 3½ percent of GDP relative to the baseline.
  - If government wages are indexed to CPI inflation, the net fiscal impact from devaluation would become negative.
- Direct fiscal impact (baseline assumptions):
  - Percent change in rufiyaa/USD exchange rate: 25.0
  - Total revenue and grants: 2.7
    - Dollar-linked components: 2.5
    - Inflation-linked components: 0.4
    - Other: 2/-0.2
  - Total expenditure and net lending: -0.8
    - Dollar-linked components: 1.3
    - Inflation-linked components: 0.9
    - Other: 2/-3.1
  - Net impact (relative to baseline): 3.5
- Direct + indirect channels (baseline):
  - Direct effect net impact: 3.5
  - Indirect effects: Import demand effect: -1.6; Real growth effect: -0.2
  - Net impact (combined): 1.7
- Wage-indexed scenario:
  - Direct effect net impact: 6.2
  - Indirect effects: Import demand effect: -3.4; Real growth effect: -0.3
  - Net impact (combined): 2.5
- Alternative contraction scenario (higher contraction in real GDP growth rate relative to baseline: 2.0%):
  - Net impact (25.0 depreciation, wage indexed, higher contraction): -4.9
- Memorandum parameters:
  - Pass through of a nominal exchange rate change to the CPI = 0.8
  - Pass through to the GDP deflator = 0.6
  - Share of imports consumed by government = 0.05
  - Price elasticity of demand = -0.5

### Box 1 — Cross-country perspective on tourism-dependent economies (selected)
- TDE definition: 28 countries with average tourism receipts-to-GDP ratio over the last 10 years > 10 percent.
- Maldives: real per capita growth declined 3.9 percent in 2009 (compared with a median of 3 percent for TDEs and 0.9 for RoW).
- Maldives tourist arrivals by nationality (Jan-Nov 2010 relative to Jan-Nov 2009; selected entries preserved):
  - Total: Composition 100.0, Growth -4.0 / 21.6
  - Europe: Composition 70.5 / 63.5, Growth -7.1 / 9.7
  - Asia: Composition 23.7 / 30.7, Growth 6.9 / 56.6
  - o/w China: Composition 9.2 / 15.7, Growth 46.1 / 101.0
  - o/w Japan: Composition 5.6 / 4.9, Growth -4.1 / 5.5
  - America: Composition 2.3 / 2.3, Growth 4.7 / 22.2
  - o/w U.S.A.: Composition 1.4 / 1.4, Growth 6.6 / 21.9
  - Others: Composition 3.5 / 3.6, Growth -9.9 / 22.5
- Exchange rate regimes among TDEs:
  - Of the 28 TDEs, 15 have fixed exchange rate regimes, and 13 have more flexible arrangements.
  - Fixed-peg group: average NEER changes 3.6 (appreciation).
  - Flexible regime group: average NEER changes -4.3 (depreciation).
  - Fiji officially devalued in 2009 by 20 percent against the U.S. dollar.

### Box 2 — Maldives: REER and competitiveness (selected)
- The rufiyaa has appreciated by 5.6 percent in real effective terms since mid-2008.
- Quantitative Exchange Rate Assessment (selected lines preserved exactly):
  - Baseline Scenario
    - Macroeconomic balance 2/ -9.5 -32.2 54.2 -13.9 -39.2
    - External sustainability 2/ -0.4 -32.2 75.8 -5.7 -39.2
  - Adjustment Scenario
    - Macroeconomic balance 2/ -9.5 -32.2 52.1 -13.9 -21.3
    - External sustainability 2/ -0.4 -32.2 72.9 -5.6 -21.3
  - Additional numeric summary line:
    - 2010 2015 Current Account Balance Current Account Balance Real Effective Exchange Rate 60.4 80.3 17.0 36.0
- Elasticity and norm assumptions:
  - Medium-run elasticity of export volumes w.r.t. REER -0.71.
  - Medium-run elasticity of import volumes w.r.t. REER 0.92.
  - NFA to GDP norm -81.9.
  - Medium-run equilibrium nominal GDP growth rate 7.4 percent.

### Public Financial Management (PFM) reforms and Joint Management Action Plan (Fund–World Bank)
- PFM progress:
  - Treasury Single Account (TSA) work advanced; Public Accounting System (PAS) functioning as basic payments processing system and can generate financial statements.
  - Financial Controller’s Office produced annual financial statements for 2009 and submitted them to the Auditor General.
- Remaining PFM tasks:
  - Bring 30-plus commercial bank accounts outside the TSA into PAS.
  - Complete PAS modules for periodic budget execution reports; target fully operational by mid-2011.
  - World Bank assisting integration of a payroll module to PAS.
- Fiscal risk monitoring priorities:
  - Key fiscal risks: financing shortfalls; cost overruns in government projects; uncertain costs of political decisions (e.g., Decentralization Act).
- Fiscal Responsibility Law (FRL) recommended elements:
  - Require medium-term strategy with numerical fiscal targets; publish monthly reports on budget execution; require Majlis to assess cost of new spending initiatives.
- Joint Fund–Bank work program (selected missions and TA, 2010–2011):
  - Fund: Program review missions Nov-10, Mar-11, Jun-11, Sep-11; Cash management TA — Mar-11.
  - Bank: Lead Poverty and Social Impact Analysis of electricity tariff increases; support universal cash transfer program; public debt management support.
- Debt sustainability assessment (joint):
  - Baseline projection under current policies: Public debt present value expected to reach 306 percent of GDP by 2030.
  - Risk of public external debt distress increased from moderate to high since 2009 DSA.
  - Indicative thresholds for medium performers (PPG external debt only): PV debt-to-GDP 40 percent; PV debt-to-exports 150 percent; PV debt-to-revenue 250 percent; Debt service-to-exports 20 percent; Debt service-to-revenue 30 percent.

### Selected economic and fiscal indicators (selected series and projections)
- Population (in 1,000; 2009 est.): 315
- GDP per capita (in U.S. dollars; 2009 est.): 4,189
- Quota (in million SDRs): 8.2
- Public and publicly guaranteed debt: 62.9 (percent of GDP) [as reported in selected table]
- Output and prices (Annual percentage change, selected):
  - Real GDP: 2009: -2.3; 2010 Est.: 4.8; 2011 Proj.: 4.0; 2012 Proj.: 4.1
  - Inflation (period average): 2009: 4.0; 2010 Est.: 5.0; 2011 Proj.: 5.5; 2012 Proj.: 4.8
- Central government finances (In percent of GDP, selected):
  - Revenue and grants: 2009: 35.9; 2010 Est.: 35.5; 2011 Proj.: 39.4; 2012 Proj.: 42.3
  - Expenditure and net lending: 2009: 64.9; 2010 Est.: 53.4; 2011 Proj.: 60.7; 2012 Proj.: 61.1
  - Overall balance: 2009: -29.0; 2010 Est.: -17.9; 2011 Proj.: -21.3; 2012 Proj.: -18.8
  - Public and publicly guaranteed debt: 2009: 85.0; 2010 Est.: 87.6; 2011 Proj.: 91.7; 2012 Proj.: 101.8
- Balance of payments (In percent of GDP, selected):
  - Current account: 2009: -30.9; 2010 Est.: -32.3; 2011 Proj.: -37.1; 2012 Proj.: -35.6
  - Gross international reserves (in millions of US$; e.o.p.): 2009: 262; 2010 Est.: 351; 2011 Proj.: 254; 2012 Proj.: 65
  - Gross international reserves in months of GNFS imports: 2009: 2.8; 2010 Est.: 3.2; 2011 Proj.: 2.0; 2012 Proj.: 0.5
- Memorandum: GDP (in millions of rufyiaa): 2010 Est.: 18,835; 2011 Proj.: 20,656; 2012 Proj.: 22,518

### Staff appraisal — key conclusions
- The 2011 budget worsens an already unsustainable fiscal stance; under the baseline public debt would rise steadily and the risk of debt distress has increased from moderate to high.
- Considerable fiscal adjustment is necessary to maintain debt sustainability; stronger public financial management is critical.
- Monetary policy stance broadly appropriate; MMA should continue tightening to stem currency pressures and strengthen confidence.
- The real exchange rate is significantly overvalued and unsustainable; an exchange rate adjustment should be part of a comprehensive restoration strategy.
- Financial sector: reasonable capitalization, profitability, and liquidity but significant vulnerabilities remain (credit quality poor; heavy sovereign exposure); enforce prudential regulations.
- Completion of the second review contingent on agreement on a strong fiscal and external adjustment strategy with credible prior actions.
- The next Article IV consultation is expected to be held in accordance with Decision No. 14747-(10/96), as amended.

*Source: IMF staff report, “Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses” (Maldives country report excerpts).*

### 1. Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses:

### 1. Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses

### Background
- In 2009 the Government of Maldives implemented a comprehensive adjustment program supported by the Fund to address severe fiscal and external imbalances driven by an unsustainable increase in public spending after the 2004 tsunami and by the global crisis.
- The program (approved December 2009) centered on:
  - strong fiscal adjustment to restore medium-term sustainability;
  - monetary tightening and cessation of deficit monetization;
  - measures to strengthen the banking sector.
- Implementation slippages have occurred: delays in key tax reforms, earlier-than-envisaged restoration of wages, and lack of progress on public employment restructuring.
- Political environment: deep polarization and strained executive–parliament relations; local island-level elections scheduled for February 2011 could delay reforms.

### Recent economic developments
- Output and tourism:
  - Real GDP contracted by 2¼ percent in 2009.
  - Real GDP growth is projected at 4¾ percent in 2010.
  - Tourism recovery by November 2010: tourist arrivals up 20 percent y/y and bednights up 18½ percent y/y.
  - Spending per tourist per day reported to have fallen; fishing sector continues secular decline.
- Inflation:
  - Inflation projected at an average of 5 percent in 2010, driven by international commodity prices and local fish prices.
- Monetary and financial sector:
  - Monetary tightening and cessation of deficit monetization reduced excess liquidity; reserve money fell through September 2010 but rose sharply after end-October due to a large increase in foreign currency deposits associated with airport privatization parent funding.
  - Broad money is expected to increase by 16¾ percent in 2010.
  - Private sector credit has stalled; bank purchases of T-bills have pushed up overall credit.
  - Financial dollarization: large influx of foreign currency deposits recently.
  - Banking sector vulnerabilities:
    - Aggregate capitalization appears adequate but asset quality deteriorated due to exposure to tourism-related borrowers.
    - Banks’ gross claims on government represent 18 percent of assets and 28 percent of loans.
    - Bank of Maldives (BML) has very large non-performing loans and faces dollar liquidity stresses.
- External sector:
  - Current account deficit is expected to have increased to about 32¼ percent of GDP in 2010.
  - International reserves (usable reserves exclude short-term foreign liabilities and foreign exchange deposits at the MMA) fell from $150 million in April 2010 to $87 million by end-October 2010, then were boosted by airport privatization proceeds of $74 million in November 2010.
  - Parallel market premium increased to around 10 percent.
  - Real effective exchange rate (REER) has appreciated since mid-2008.
- Fiscal sector:
  - Preliminary revenue and expenditure data point to under-execution of the budget and a 2010 fiscal deficit close to the program target of 17¾ percent of GDP; financing data indicate a deficit of around 20¼ percent of GDP.
  - Debt revised down relative to initial projections due to larger-than-expected privatization inflows (estimated at about $97 million in 2010) and better information on SOE-guaranteed debt.

### Policy discussions — Growth, competitiveness, and medium-term outlook
- Long-run growth prerequisites:
  - Macroeconomic stability and structural reforms to enhance competitiveness (education, infrastructure, ease of doing business).
  - Tourism to remain engine of growth; diversification into other industries, including services such as outsourcing, required for further progress.
- Exchange rate and competitiveness:
  - CGER-type analysis indicates a significant real exchange rate overvaluation on current policies.
  - Significant fiscal consolidation, possibly with a nominal devaluation, would be needed to bring the REER to a sustainable path.
- Medium-term projections and risks:
  - A gradual growth recovery is expected with rates around 4½ percent over the medium term.
  - On current policies the current account deficit would remain high, potentially leading to reserve depletion and an external financing gap.
  - Global risks broadly balanced; domestic risks tilted to the downside—slow fiscal consolidation, persistent external imbalances and dollar shortages, and political tensions could undermine sustainability and tourism.

### Fiscal policy — recent measures, slippages, and quantified impacts
- Key recent fiscal developments undermining adjustment:
  - T-GST passed in August 2010 at 3½ percent instead of 4 percent; parallel bill maintained the $8 bed tax through end-2013 (no offsetting increase in T-GST).
  - Business profit tax (BPT) passed in December 2010 to enter into effect July 2011, eighteen months later than planned.
  - Implementation of the general GST delayed due to administrative capacity constraints.
  - No net fiscal savings from public employment restructuring; wages restored to September 2009 levels from January 2011 (one year earlier than programmed).
  - New Decentralization and Disability Bills will increase spending.
  - In 2011–2012 the deficit expected to be offset by temporary payments for resort lease extensions; loss of these payments from 2013 and elimination of the $8 bed tax would sharply increase the deficit from 2014.
- Staff estimates of deviations from program projections (Deviations from program projections, in percent of GDP):
  - Revenue and grants: 2010 -0.8; 2011 -3.3; 2012 -0.8
  - SOE transfers: 2010 2.8; 2011 0.8; 2012 0.7
  - Delay of, and base revisions for BPT: 2010 -1.6; 2011 -1.6; 2012 -0.3
  - Changes associated with implementation of T-GST (net): 2010 -3.9; 2011 -1.6; 2012 0.4
    - delay in entry into effect: 2010 -1.1; 2011 0.0; 2012 0.0
    - change in rate from 4 percent to 3.5 percent: 2010 0.0; 2011 -0.6; 2012 -0.7
    - proposed changes to resort lease payment regime: 2010 -2.8; 2011 -1.7; 2012 0.4
  - Revised timetable for implementation of the general GST: 2010 0.0; 2011 -2.2; 2012 -2.9
  - Other (net): 2010 0.8; 2011 -1.8; 2012 -1.7
  - Expenditure deviations (selected):
    - Pensions (7% employee contribution taken on by govt): 2010 0.5; 2011 0.0; 2012 0.0
    - Salaries and wages: 2010 1.4; 2011 6.2; 2012 4.1
    - Limited progress on redundancies: 2010 2.5; 2011 2.4; 2012 2.3
    - Restoration of wages: 2010 -1.1; 2011 2.8; 2012 0.7
    - Employment associated with Decentralization Bill: 2010 0.0; 2011 1.0; 2012 1.1
    - Social welfare contributions: 2010 -0.8; 2011 2.6; 2012 3.1
      - disability benefits (2011q1~): 2010 0.0; 2011 1.4; 2012 1.4
    - Capital expenditure: 2010 -0.4; 2011 5.1; 2012 6.8
    - Other (net): 2010 -1.0; 2011 0.0; 2012 0.4
  - Total increase in fiscal deficit relative to program targets: 2010 0.4; 2011 17.2; 2012 15.3
- Comparison of the 2011 Budget and IMF Baseline Projections (Millions of rufiyaa; percent of GDP where indicated):
  - Revenue and grants: Budget 8,874; IMF Baseline 8,136; Difference -3.6
  - Business profit tax: Budget 613; IMF Baseline 260; Difference -1.7
  - Administrative fees and charges 2/: Budget 1,184; IMF Baseline 684; Difference -2.4
  - Other revenue: Budget 4,703; IMF Baseline 4,723; Difference 0.1
  - Expenditure and net lending: Budget 12,164; IMF Baseline 12,549; Difference 1.9
  - Disability Act cost: Budget 108; IMF Baseline 28; Difference 0.8
  - Interest payments: Budget 601; IMF Baseline 768; Difference 0.8
  - Other expenditure: Budget 3,135; IMF Baseline 3,135; Difference 0.0
  - Overall balance: Budget -3,290; IMF Baseline -4,413; Difference -5.4
  - Miscellaneous: Nominal GDP 1/: Budget 20,656; IMF Baseline 20,656
  - Note: The budget included Rf 500 mn of proceeds from land sales.
- Authorities’ GDP rebasing:
  - Authorities informed staff that national accounts rebasing is underway and expected to lead to a significant upward revision of historical GDP, with revised data expected January 2011. Staff notes that a large increase in GDP would affect magnitudes of imbalances but not the direction of policy changes needed.

### Policy priorities and recommendations (implied by staff analysis)
- Implement outstanding fiscal adjustment measures under the program and adopt additional fiscal consolidation to restore sustainability.
- Maintain monetary tightening and avoid deficit monetization to stabilize liquidity and reserve dynamics.
- Consider exchange rate adjustment (nominal devaluation) alongside fiscal consolidation and wage restraint to correct REER overvaluation.
- Strengthen public financial management and implement financial sector reforms to increase resilience, including addressing banks’ asset quality, provisioning, and sovereign exposure.
- Advance structural reforms to improve competitiveness: broaden and improve education and infrastructure, and ease of doing business reforms to support diversification beyond tourism.

*Source: IMF staff report, “Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses” (Maldives country report excerpts).*

### 15.      The 2011 budget, approved by the Majlis at end-December 2010, entails a

### _cr11293 - 15.      The 2011 budget, approved by the Majlis at end-December 2010, entails a

### Fiscal stance and baseline projections
- The 2011 budget provides for a 21 percent increase in government spending relative to preliminary 2010 data.
- Capital expenditure in the 2011 budget increases by 37 percent.
- The budget projects a fiscal deficit of 16 percent of GDP, but staff adjustments raise this to 21¼ percent of GDP, a 3½ percent of GDP expansion compared with 2010.
- Under the staff baseline (incorporating policy slippages, adjusted 2011 budget, and assumption that the G-GST comes into effect in January 2013), staff projects:
  - Fiscal deficit at 19 percent of GDP in 2012.
  - Debt reaching 135 percent of GDP in 2015 and over 300 percent by 2030.
- The risk of debt distress has increased from moderate to high.

### Financing needs and fiscal risks
- Outstanding stock of T-bills was over Rf 4 bn (21 percent of GDP) by end-2010, most with maturities of three months or under.
- Government gross financing needs in 2011 are estimated at 45½ percent of GDP.
- Recent amendments to the Public Finance Act require legislative consent for external borrowing and lease or sale of state assets; these could limit financing options and jeopardize privatization plans.
- Privatization and land sales in 2011 include US$154 million (9½ percent of GDP) from land sales and the divestment of the telecoms company.
- Expiration of lease extension payments from 2013 and elimination of the $8 bed tax would cause the fiscal deficit to balloon from 2014.

### Recommended expenditure-side measures
- Implement a realistic and well-planned redundancy program across central government employment to:
  - Fully offset fiscal effects of the Decentralization Bill (estimated at over 1,000 jobs).
  - Achieve a net reduction in central government employment of around 2,000 jobs (about 5 percent) by end-2011 and a further 2,000 by end-2012.
  - Provide an attractive but affordable redundancy package (baseline assumes six months of salary, compared with a legally-mandated three months).
  - Reduce number and remuneration of political appointees to 2008 levels.
- Preserve welfare expenditure on the poor by improving targeting of subsidies and transfers; continue replacing subsidies with targeted transfers (noting the 2009 revision of electricity subsidies).
- Focus on high-priority capital projects already in the pipeline:
  - Cut 2011 capital expenditures by 2½ percent of GDP (relative to the budget) to 10 percent of GDP, and maintain at that share in 2012–13.
  - Limit growth in operating expenditures in 2011 over 2010 to CPI inflation, implying savings of 1¼ percent of GDP in 2011 relative to the budget.

### Recommended revenue-side measures
- Continue preparing for implementation of the T-GST, the BPT, and the G-GST at a rate of 6 percent in January 2013 (reflected in the baseline).
- Submit additional revenue measures to the Majlis as a package; staff recommended:
  - Introduction of excises on alcohol, tobacco, jet fuel, gasoline, and vehicles, to come into effect in July 2011.
  - Passage of a provision in the T-GST Act so that its rate goes up to 6 percent when the bed tax is eliminated at end-2013.

### Quantified fiscal impact of additional adjustment measures (In percent of GDP)
- Total: 2011 = 6.6; 2012 = 10.9
- Excises on gasoline and jet fuel (2011q3~): 2011 = 0.8; 2012 = 1.4
- Excises on alcohol and tobacco (2011q3~): 2011 = 1.1; 2012 = 2.0
- Excises on vehicles and parts (2011q3~): 2011 = 0.6; 2012 = 1.1
- Redundancy program 1/: 2011 = 0.5; 2012 = 2.4
- Cuts in non-wage, non-interest operating expenditures 1/: 2011 = 1.3; 2012 = 0.0
- Cuts in capital expenditures 1/: 2011 = 2.4; 2012 = 4.0
- Source: Fund staff estimates, based on data from the authorities.
- 1/ Relative to baseline projections.

- An adjustment scenario reflecting all these measures projects the fiscal deficit would fall to 8 percent of GDP in 2012 and 5½ percent by 2015.
- Even with these measures, debt-to-GDP would remain about current levels through 2015 and fall very slowly thereafter, leaving vulnerability to shocks (including possible court-mandated restoration of wages from January 2010 at a cost of 3 percent of GDP); international reserve coverage would decline below adequate levels; and the current account deficit would remain elevated.
- To regain sustainability, the fiscal measures need to be coupled with a significant exchange rate adjustment (paragraph 22).

### Public financial management (PFM) reforms
- Stronger PFM is needed to support consolidation; current slippages include introduction of spending without proper costing and lack of timely fiscal monitoring/reporting.
- Mission recommendations:
  - Expedite completion of PEFA assessment recommendations (budget execution, expenditure control, managing fiscal risks).
  - Migrate foreign-financed expenditure data to the public accounts system.
  - Improve budget preparation and planning, including cost-benefit analyses for domestically-financed capital expenditures.
  - Move to medium-term budgeting.
  - Adopt a fiscal responsibility framework, in line with recent FAD TA recommendations.
  - Generate monthly fiscal outturn reports.
  - Create a policy unit at the Ministry of Finance and Treasury to monitor fiscal developments and analyze policy impacts.

### Political economy and authorities’ views
- Broad political support may be required for successful and sustainable fiscal adjustment given a fractious political environment.
- Authorities concur with staff’s fiscal assessment but prefer a smoother medium-term adjustment; they indicated the 2011 budget would provide for a fiscal deficit of no less than 15 percent of GDP.
- Authorities expect financing for a slow fiscal adjustment from domestic and external sources, particularly bilateral creditors, and privatization.
- Authorities agreed on the need to seek broad political support for fiscal adjustment.

### Monetary and exchange rate policy
- Staff and authorities agreed a significant exchange rate adjustment is needed to restore fiscal and external sustainability; the real exchange rate is significantly overvalued.
- A discrete devaluation or a depreciation under a float would help reduce external imbalances if accompanied by monetary and wage restraint, owing to high pass through to domestic prices.
- A devaluation would yield considerable fiscal gains provided nominal public wages are frozen.
- Trade-offs discussed:
  - Step devaluation: preserves nominal anchor and control over short-run path; if insufficient could trigger speculative runs; would need to be large (of the order of 20–30 percent) and supported by credible fiscal consolidation.
  - Float/managed float: would avoid using reserves to defend the peg; shallow domestic markets and vulnerability to shocks imply high volatility; managed float preferred to pure float to stem volatility, but risks include overshooting and loss of nominal anchor.
- The MMA should continue to tighten monetary policy to rein in expansion in broad money and reduce pressures on the currency; continued liquidity tightening would complement a devaluation and check inflation expectations.
- Authorities will review foreign exchange regulations and, if changing regimes, seek Fund technical assistance.

### Financial sector policies and reforms
- MMA should enforce prudential regulations; agreement reached with banks to comply with single borrower limits, asset classification and provisioning, and foreign currency exposure limits by end-2011; other prudential regulations are already fully complied with.
- Staff recommended regular stress testing (interest rate, exchange rate, NPLs) and preparing an overall crisis preparedness and management strategy; staff proposed vulnerability indicators to be closely monitored.
- Banks are long in dollars; a devaluation would directly benefit banks, and negative impact on dollar loans to non-dollar earners is likely small.
- Recommendations for BML:
  - Recapitalize BML.
  - Conduct a diagnostic evaluation by an independent audit firm.
  - Strengthen management.
- Progress noted:
  - Enactment of the Banking Act.
  - MMA implementing safeguards assessment recommendations: appointment of an international external auditor firm, audited statements published, steps toward adopting IFRS; appointment of an internal auditor delayed by lack of suitable applicants.
- IMF is assessing Maldives’ AML/CFT framework; an onsite mission in October 2010 found significant shortcomings in preventive measures for financial institutions and AML/CFT supervision; the draft assessment report to be discussed during the July 2011 plenary meeting of the Asia/Pacific Group on Money Laundering.

### Program performance and external financing
- All performance criteria for March and June 2010 were met, as were indicative targets for September 2010.
- The December 2010 IT for reserve money was breached due to a rapid increase in foreign currency bank reserves at the MMA; preliminary information suggests the fiscal deficit financing IT was breached by a very large margin.
- Agreement on a strong adjustment strategy with credible prior actions is needed for completion of the second review; the strategy may entail looser short-run numerical fiscal targets while converging to program targets in the medium term.
- For 2011, total external financing requirements are projected to increase to $933 million.
- Continued delays in completion of the Fund program review could trigger suspension of financing from the World Bank and the Asian Development Bank, leading to a total fall in multilateral financing of $73 million in 2011.

### Staff appraisal — key conclusions
- The 2011 budget worsens an already unsustainable fiscal stance; under the baseline public debt would rise steadily and the risk of debt distress has increased from moderate to high.
- Considerable fiscal adjustment is necessary to maintain debt sustainability; stronger public financial management is critical.
- Monetary policy stance has been broadly appropriate; MMA should continue tightening to stem pressures on and strengthen confidence in the currency.
- The real exchange rate is significantly overvalued and unsustainable; an exchange rate adjustment should be part of a comprehensive restoration strategy.
- Financial sector: system shows reasonable capitalization, profitability, and liquidity but significant vulnerabilities remain (credit quality poor; heavy sovereign exposure); enforce prudential regulations, especially on provisioning, single borrower limits, and foreign currency exposure.
- Completion of the second review will be contingent on agreement on a strong fiscal and external adjustment strategy with credible prior actions.
- The next Article IV consultation is expected to be held in accordance with Decision No. 14747-(10/96), as amended.

*Source: IMF staff report (content unit: _cr11293 - 15. The 2011 budget, approved by the Majlis at end-December 2010, entails a).*

### Box 1. Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses:

### Box 1. Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses: A Cross-country Perspective

### Impact on tourism receipts and growth
- The 2008–09 global crisis caused tourism receipts to fall throughout the world; the impact was much stronger than during the 2001 global slowdown.
- TDEs experienced a less severe decline in tourism receipts than the median for the rest of the world (RoW), but their higher tourism exposure translated into a larger negative impact on real per capita growth.
- Specific figures:
  - TDE definition: the 28 countries for which the average of the tourism receipts-to-GDP ratio over the last 10 years was greater than 10 percent.
  - RoW category: the remaining 136 countries in the 164-country sample.
  - Maldives: real per capita growth declined 3.9 percent in 2009 (compared with a median of 3 percent for TDEs and 0.9 for RoW).

### Country example — Maldives: tourism composition and recovery
- Recovery in Maldives aided by arrivals from new and fast-growing markets, particularly China.
- Table 1 (Maldives: Tourist Arrivals by Nationality) highlights composition and growth (period Jan-Nov 2010 relative to Jan-Nov 2009); selected entries preserved exactly as in source:
  - Total: Composition 100.0, Growth -4.0 / 21.6
  - Europe: Composition 70.5 / 63.5, Growth -7.1 / 9.7
  - Asia: Composition 23.7 / 30.7, Growth 6.9 / 56.6
  - o/w China: Composition 9.2 / 15.7, Growth 46.1 / 101.0
  - o/w Japan: Composition 5.6 / 4.9, Growth -4.1 / 5.5
  - America: Composition 2.3 / 2.3, Growth 4.7 / 22.2
  - o/w U.S.A.: Composition 1.4 / 1.4, Growth 6.6 / 21.9
  - Others: Composition 3.5 / 3.6, Growth -9.9 / 22.5
- Table note: 1/ Composition for 2010 is calculated for the period of Jan-Nov 2010, and growth for 2010 is calculated relative to Jan-Nov 2009.

### Inflation, fiscal balances, and public debt
- Inflation:
  - The impact on inflation in TDEs has been moderate, with inflation generally following international commodity prices.
  - Notable exception: Seychelles experienced a significant inflation spike following a sharp exchange rate depreciation after 2007.
- Fiscal response:
  - Median fiscal deficit of TDEs widened by about 2–3 percentage points of GDP, very similar to the median for the RoW.
  - Maldives: fiscal deficit increased by more than 20 percentage points of GDP, leading to a rapid build-up of public debt to a much higher level (on average) than other TDEs and the RoW.
- Figures referenced:
  - Figure 4: CPI Inflation in Tourism-dependent Economies (group medians, in percent).
  - Figure 5: Fiscal Balances in Tourism-dependent Economies (general government revenue minus expenditures).
  - Figure 6: Government Debt in Tourism-dependent Economies (group medians; in percent of GDP).

### Exchange rate outcomes and policy regimes
- Aggregate outcomes:
  - Of the 28 TDEs, 15 have fixed exchange rate regimes (includes currency board regimes), and 13 have more flexible exchange rate arrangements.
  - Fixed-peg group: average NEER changes (in percent) 3.6 (appreciation).
    - Countries that officially devalued: 1; How much? (Average NEER changes, in percent) -13.5.
  - Flexible regime group: average NEER changes (in percent) -4.3 (depreciation), which helped cushion the negative shock.
  - Fiji officially devalued in 2009 by 20 percent against the U.S. dollar.
- Figures and tables:
  - Table 2: Exchange Rate Responses in Tourism-dependent Economies during Recent Crises, 2009.
  - Figure 7: Nominal Effective Exchange Rate Changes in Tourism-dependent Economies (group medians, in percent).

### Box 2 (Maldives): Exchange rate, external sustainability, and competitiveness
- REER and competitiveness:
  - The Maldivian rufiyaa has appreciated by 5.6 percent in real effective terms since mid-2008, in the face of relatively high domestic inflation.
  - The REER is now roughly in line with the average of the past ten years.
  - Maldives has remained competitive relative to relevant comparators; over the past decade Maldives’ REER path remained below those of some relevant competitors for high-end tourism, except Seychelles.
  - Recent REER appreciation and a difficult business environment pose challenges going forward.
- Competitiveness indicators (Table 1, Maldives: Competitiveness Indicators):
  - Ease of Doing Business Rank (scale 1 to 183, lower is better) and Growth in tourist arrivals (average over last 8 years):
    - Bahamas: Ease of Doing Business 71 / 77, Growth 0.7 / 1.5
    - Dominican Republic: 86 / 91, Growth 4.4 / 4.7
    - Madagascar: 138 / 140, Growth 23.1 / 19.9
    - Maldives: 96 / 85, Growth 7.2 / 7.0
    - Mauritius: 20 / 20, Growth 4.7 / 3.8
    - Seychelles: 92 / 95, Growth 2.9 / 2.9
    - Sri Lanka: 102 / 102, Growth 3.1 / 4.6
  - Table notes: 1/ Ease of Doing Business rank covers June 2009 through May 2010; rank for 2009 changed due to methodology revisions. 2/ Average growth in arrivals is an average over the last 8 years.
- Quantitative Exchange Rate Assessment (Table 2, Maldives):
  - Results reported based on a GMM estimator applied to 184 countries (Vitek 2010); all figures are based on five year conditional forecasts and are expressed in percent.
  - Underlying assessment summary (preserved exactly as in source):
    - Baseline Scenario
      - Macroeconomic balance 2/ -9.5 -32.2 54.2 -13.9 -39.2
      - External sustainability 2/ -0.4 -32.2 75.8 -5.7 -39.2
    - Adjustment Scenario
      - Macroeconomic balance 2/ -9.5 -32.2 52.1 -13.9 -21.3
      - External sustainability 2/ -0.4 -32.2 72.9 -5.6 -21.3
  - Additional numeric summary line:
    - 2010 2015 Current Account Balance Current Account Balance Real Effective Exchange Rate 60.4 80.3 17.0 36.0
  - Interpretation in text:
    - CGER-type methodologies suggest that the REER is inconsistent with medium-term fundamentals under the baseline scenario. For given elasticities, this implies that the REER is significantly overvalued.
    - The analysis suggests that even the illustrative fiscal adjustment scenario is insufficient to narrow the underlying imbalances. Stronger measures, including an exchange rate adjustment, are needed.
  - Elasticity and norm assumptions (preserved as in source):
    - Medium-run elasticity of export volumes w.r.t. REER -0.71.
    - Medium-run elasticity of import volumes w.r.t. REER 0.92.
    - NFA to GDP norm -81.9.
    - Medium-run equilibrium nominal GDP growth rate 7.4 percent.

### Box 3: Maldives public financial management reforms
- Progress:
  - Authorities have taken important steps to implement immediate priorities from the 2009 PEFA assessment to improve public financial management (PFM).
  - Much work toward establishing a Treasury Single Account (TSA) has been done.
  - The Public Accounting System (PAS) is functioning as a basic payments processing system and can generate financial statements.
  - With PAS functionality in place, the Financial Controller’s Office produced annual financial statements for 2009 as scheduled in the PFM reform action plan, and submitted them, for the first time ever, to the Auditor General.
- Remaining tasks:
  - Need to bring into the PAS the 30-plus commercial bank accounts that remain outside the TSA, all associated with project funding from donors.
  - PAS modules for generating periodic reports on budget execution need to be completed; the authorities’ goal is to have them fully operational by mid-

*Source: _cr11293 - Box 1. Impact of the Global Crisis on Tourism-dependent Economies and Policy Responses*

### 2011. In addition, the World Bank has been assisting the authorities in integrating a payroll

### _cr11293 - 2011. In addition, the World Bank has been assisting the authorities in integrating a payroll

### Public Financial Management (PFM) reforms and recent actions
- The World Bank has been assisting the authorities in integrating a payroll module to the PAS, to allow for timely and accurate monitoring of the wage bill.
- Additions (including the payroll module) are expected to:
  - enhance cash flow and debt management;
  - improve program budgeting, to which the authorities made a transition in the 2011 budget.

### Fiscal risk monitoring and priorities
- Establishing a framework for monitoring and managing fiscal risks is identified as essential and a high-priority area by the PEFA assessment.
- Key fiscal risks include:
  - financing shortfalls;
  - cost overruns in government projects;
  - uncertain costs of political decisions (e.g., the Decentralization Act).

### Fiscal Responsibility Law (FRL): recommended design elements
- Adopting a fiscal responsibility law would:
  - require the administration to lay out its medium-term strategy, including numerical fiscal targets;
  - improve budget formulation;
  - require publication of monthly reports on budget execution (including explanations for major deviations);
  - require the Majlis to assess the cost of new spending initiatives.
- Consider creating a politically-independent entity to assess the fiscal impact of new revenue and expenditure policies in light of the medium-term budget objectives.

### Capacity constraints and implementation risks
- Capacity constraints in public finance administration must be addressed immediately as a prerequisite for sustainable PFM reform.
- A critical problem is high turnover of trained staff, leading to inadequate staffing and skills levels.

### Selected economic and fiscal indicators (as reported)
- Population (in 1,000; 2009 est.): 315
- GDP per capita (in U.S. dollars; 2009 est.): 4,189
- Quota (in million SDRs): 8.2
- Public and publicly guaranteed debt: 62.9 (percent of GDP)

*Source: Maldivian authorities, and Fund staff estimates and projections.*

### Appendix 1. Maldives: Estimated Fiscal Impact of a Devaluation

### Appendix 1. Maldives: Estimated Fiscal Impact of a Devaluation

### Main finding: direct fiscal impact under wage freeze versus indexation
- If nominal wages remain constant, a 25 percent nominal depreciation could improve the fiscal balance by about 3½ percent of GDP relative to the baseline.
- If government wages are indexed to CPI inflation, the net fiscal impact from devaluation would become negative (expenditure increases more than revenue gains).
- If nominal wages are kept constant temporarily but later allowed to catch up retroactively, the fiscal gains would be temporary; for permanent fiscal gains, post-freeze wage adjustments should be based on subsequent, not retroactive, inflation.

### Direct fiscal impact (baseline, assumptions)
- Analysis assumptions:
  - Pass through of a nominal exchange rate change to the CPI = 0.8
  - Pass through to the GDP deflator = 0.6
  - Share of imports consumed by government = 0.05
  - Assumes nominal exchange rate change takes place on January 1, 2011; static, partial equilibrium (output and absorption volumes constant)
- Table 1 (Net Fiscal Impact of Devaluation in 2011, baseline scenario) — selected figures (In percent of GDP)
  - Percent change in rufiyaa/USD exchange rate: 25.0
  - Total revenue and grants: 2.7
    - Dollar-linked components: 2.5
    - Inflation-linked components: 0.4
    - Other: 2/-0.2
  - Total expenditure and net lending: -0.8
    - Dollar-linked components: 1.3
    - Inflation-linked components: 0.9
    - Other: 2/-3.1
  - Net impact (relative to baseline): 3.5
- Memorandum items (key parameters): Pass through to CPI = 0.8; Pass through to GDP deflator = 0.6; Share of imports consumed by government = 0.05
- Note: Dollar-denominated public debt would rise on impact from 48 percent of GDP to 52 percent with a 25 percent depreciation, but the improvement in the net fiscal balance would help reduce debt over the medium term.
- Cash-flow impact would be larger because net dollar-denominated financing (disbursements minus amortizations) for the government is expected to be positive in 2011.

### Indirect channels: import demand and growth (Table 3 simulation)
- When indirect channels are included, the total net fiscal impact is significantly smaller than under direct effects only.
- Table 3 (Net Fiscal Impact of Devaluation; Direct and Indirect Channels, baseline scenario) — selected figures (In percent of GDP)
  - Percent change in rufiyaa/USD exchange rate: 25.0
  - Direct effect:
    - Net impact (relative to baseline): 3.5
  - Indirect effects:
    - Import demand effect: -1.6
    - Real growth effect: -0.2
  - Net impact (relative to baseline, combined): 1.7
- For the scenario where the wage bill is indexed to CPI inflation:
  - Direct effect net impact: 6.2
  - Indirect effects:
    - Import demand effect: -3.4
    - Real growth effect: -0.3
  - Net impact (combined): 2.5
- Alternative contraction scenarios (higher contraction in real GDP growth rate relative to baseline: 2.0%) produce larger negative net impacts:
  - Net impact (25.0 depreciation, wage indexed, higher contraction): -4.9
- Memorandum items:
  - Price elasticity of demand = -0.5
  - Contraction in real GDP growth rate (relative to baseline) considered: 1.0% and 2.0%

### Channels explained
- Price-elasticity of import demand (static) effect:
  - Devaluation reduces import demand on impact through substitution and income effects.
  - In Maldives, limited scope for import substitution; large negative price-income effect on imports as domestic incomes fall in dollar (and real) terms.
  - Because import tariff revenue is the largest component of tax revenue, the negative fiscal effect through reduced import demand is likely to be considerable.
- Real GDP growth effect:
  - Given high import dependence, devaluation is likely mildly contractionary in the short run but expansionary in the medium run once supply effects (mainly from lower real wages) work through the economy.
  - Growth channel affects fiscal outcomes through import demand (dynamic effect) and domestic revenue bases (profits tax, profit transfers); overall fiscal effect likely relatively small.

### Classification of fiscal components used in analysis (Table 2 categories)
- Revenue categories:
  - Dollar-linked components: Import duties; tourism bed-night tax; airport tax; T-GST; royalties; resort and land rent; grants
  - Inflation-linked components: License fees; interest income
  - Other: Bank profit tax; business profit tax (proposed); SOE profit transfers; administrative fees and charges
- Expenditure categories:
  - Dollar-linked components: Interest payments (computed based on share of dollar-denominated debt); capital expenditures (assumes 80 percent dollar linked); government consumption of imports
  - Inflation-linked components: Wages and salaries; allowances (two simulations: freeze in nominal wages vs. indexed to CPI)
  - Other: All other non-wage, non-interest operating expenditures; net lending

### Implications for policy and debt dynamics
- A nominal depreciation combined with public sector wage restraint (freeze) can generate substantial immediate fiscal gains (about 3.5 percent of GDP for a 25 percent depreciation), which could help reduce debt over the medium term despite an immediate rise in dollar-denominated public debt share.
- If wages are indexed to inflation, devaluation increases the fiscal deficit.
- Temporary freezes yield temporary gains unless subsequent wage adjustments exclude retroactive inflation compensation.

### Appendix 2 — Exchange rate pass-through to CPI and empirical evidence
- Supply-and-Use based estimate:
  - Total exchange rate pass through into the CPI ≈ 0.79 (i.e., a 10 percent increase in the exchange rate leads to a 7.9 percent increase in consumer prices).
- Calibrated estimate allowing for substitution and distribution margins (Campa and Goldberg approach):
  - Pass-through coefficient for Maldives = 0.77
  - Campa and Goldberg sample average = 0.26
- Empirical episode (July 2001 devaluation):
  - Devaluation rate in July 2001 = 8.8
  - Average yoy change in bilateral exchange rates over t+12 (A) = 8.8
  - Average yoy inflation over t-12 (B) = -1.4
  - Average yoy change in commodity price over t+12, weighted by CPI weights (C) = -2.9
  - Average yoy inflation over t+12 (D) = 3.7
  - Pass-through into CPI estimated as (D - C - B)/A*100 = 90.6
  - Historical episode suggests very high pass through (about 90 percent).
- Structural drivers of high pass through in Maldives:
  - High import content in production and consumption
  - Lack of domestic substitutes
  - Relatively small distribution margins
- Dynamics from VAR estimation:
  - Pass through peaks in the third quarter for both PPI and CPI, with stronger initial impact on CPI.
  - Variance decomposition indicates output gap and commodity price shocks are key factors explaining PPI and CPI variations.

*Source: IMF staff estimates and calculations as presented in the document.*

### ANNEX II.  MALDIVES: JOINT MANAGEMENT ACTION PLAN

### ANNEX II. MALDIVES: JOINT MANAGEMENT ACTION PLAN

### Overall partnership framework and policy focus
- World Bank: Country Assistance Strategy (2008), confirmed in CAS progress report (2010), built around three pillars: economic governance and investment; human development and social protection; environmental management.
- IMF: Blended arrangement of SBA and ESF approved December 2009; two tranches disbursed; program on hold pending completion of the second review program targets.
- Joint focus areas: public financial management, utility pricing, social protection, fiscal consolidation, monetary tightening, banking sector strengthening.
- Collaborative roles:
  - Bank: leading Poverty and Social Impact Analysis of electricity tariff increases; supporting development of a universal cash transfer program; leading public debt management support; supporting implementation of a credible medium-term expenditure framework (MTEF); providing technical assistance and analytic work in public sector reform.
  - Fund: focusing on tax issues (e.g., support for implementation of a Goods and Services Tax); supporting drafting of a Fiscal Responsibility Law; undertaking analytical work on exchange rate and vulnerability issues; providing TA in cash and debt management.

### Joint activities, products, and timelines (2010–2011)
- Joint missions and regular briefings to support tranche releases for each institution's lending operations.
- Planned joint mission in second quarter of FY11 to provide technical assistance in debt and cash management.
- Appendix summary of macro-critical activities to be undertaken over the coming year.

Bank work program (next 12 months) — Strategy, analytical work, lending, and projects:
- Strategy and analytical work:
  - ROSC (Corporate Governance)
  - Support to Donor pledging forum (TBD)
  - Support to Tourism
  - Review Costing of HIV/AIDs Strategic Action Plan
  - Education and Skills Training Policy Notes
  - Tourism industry efforts to put in clean energy measures
- Lending program:
  - Economic Stabilization & Recovery Credit FY2010 (Development Policy Credit). Primary focus on: public financial management, public service reform, and public enterprise reform.
  - Economic Stabilization & Recovery Credit — Focus on social protection
  - Climate Change Trust Fund (EU)
  - ESW and carbon financing for energy sector initiatives
- Ongoing and new projects (FY2010):
  - Support for MMA on financial sector strategy; laws and regulations relating to financial sector
  - Leasing sector
  - Setting up a credit bureau
  - Access to finance and SME linkages
  - Bar and judiciary
  - Scoping study of local tourism industry linkages with poultry industry

Fund work program (next 12 months) — Missions, analytical work, TA:
- Missions:
  - Article IV consultation Nov-10
  - Program review missions Nov-10, Mar-11, Jun-11, Sep-11
- Analytical work:
  - The pass through of exchange rate changes to prices in Maldives — Oct-10
- Technical assistance:
  - Cash management TA — Mar-11
  - Public finance management
  - Monetary operations
  - Development of secondary market for T-bills — FY2010
  - TA on payment system reform

Requests and joint products:
- Fund request to Bank:
  - Poverty and social impact analysis of the electricity tariff increases — FY2010
- Agreed joint product:
  - Debt sustainability analysis — Dec-10 (Pending)

### Key findings from joint diagnostics and assessments (as presented)
- Coordination and sequencing:
  - Teams will continue coordination of nonprogram work, including follow-up to the joint PEFA exercise undertaken in 2009.
- Public financial management:
  - Identified as a key area of collaboration for Bank and Fund operations.
- Social protection and utility pricing:
  - Bank leading Poverty and Social Impact Analysis of electricity tariff increases required under the IMF program; work informs Bank support for universal cash transfer program development.

### Debt sustainability assessment (summary of findings)
- Baseline projection under current policies:
  - Public debt present value expected to reach 306 percent of GDP by 2030.
- Risk assessment:
  - Maldives’ risk of public external debt distress has increased from moderate to high since the 2009 DSA.
- Drivers and risks:
  - Key risks: shocks to exports and additional fiscal policy slippages.
  - Continued large current account deficits will increase pressure on total debt burden, including private external debt.
- Policy implication:
  - Current policies would lead to extremely large domestic and external financing requirements that cannot realistically be met; calls for additional fiscal consolidation measures in the near term.
- Institutional classification and indicative thresholds:
  - Maldives classified a “medium performer” by the World Bank’s CPIA, averaging 3.45 over 2007–2009.
  - Indicative thresholds for medium performers (applicable to PPG external debt only):
    - PV of debt-to-GDP ratio: 40 percent
    - PV of debt-to-exports ratio: 150 percent
    - PV of debt-to-revenue ratio: 250 percent
    - Debt service-to-exports ratio: 20 percent
    - Debt service-to-revenue ratio: 30 percent

### Statistical and data issues affecting surveillance and analysis
- General: Data provision has some shortcomings but is broadly adequate for surveillance; major shortcomings affect balance of payments, government finance, and national accounts.
- National accounts:
  - Annual GDP estimates only; production and expenditure estimates inconsistent.
  - Base year for constant price estimates: 1995.
  - Rebasing work underway; rebased series expected to be published in January 2011.
- Price statistics:
  - CPI rebased to June 2004=100; weights based on household income and expenditure survey Sep-2002 to Jun-2003 and adjusted to Jun-2004.
- Fiscal data:
  - General government data reported to GFS Yearbook; latest published data for 2009.
  - Monthly revenue and expenditure data available but reporting system is new and reliability untested; inconsistencies with monetary authorities' financing numbers.
- Monetary statistics:
  - Weekly electronic reports on monetary statistics available.
  - Integrated monetary database completed and became operational in 2010.
  - New call report form for other financial corporations expected with follow-up mission.
- External sector:
  - Balance of payments compiled annually; problems in coverage and measurement (travel receipts estimated from outdated survey; limited coverage of FDI firms; underreporting of distributed and reinvested earnings in tourism; incomplete private financial flows).
  - Quarterly data on external debt and debt service available for government and monetary authority; no data for nonfinancial private sector.
  - Official reserve assets reported weekly with a variable one-week lag.
- Data standards:
  - Maldives does not participate in the General Data Dissemination System (GDDS).
  - No data ROSC available.
- Reporting:
  - Authorities report macroeconomic data regularly and generally timely for IFS, BOPSY, and GFSY publication.

*Prepared jointly by Fund and World Bank staff; as of October 2010 (Joint Management Action Plan) and as of January 7, 2011 (statistical notes).*

### 1.      Total public debt has increased rapidly since the 2004 tsunami, from 55 percent

### 1.      Total public debt has increased rapidly since the 2004 tsunami, from 55 percent of GDP in 2004 to an estimated 89 percent of GDP in 2010

### Debt trends and composition
- Total public debt rose from 55 percent of GDP in 2004 to an estimated 89 percent of GDP in 2010 (Figure 1 and Table 1).
- Public expenditure rose from Rf 3.5 billion in 2004 to Rf 10.9 billion in 2009.
- Fiscal revenue fell from Rf 7.4 billion in 2008 to Rf 6.1 billion in 2009.
- Public external debt rose in dollar terms after the tsunami but did not substantially increase as a share of GDP; tsunami donor flows supported reconstruction.
- Notable external financing:
  - Financial assistance from India totaling US$200 million in the 2009–10 period.
  - Non-concessional $74 million loan from China.
  - Concessional borrowing of $8 million from the Saudi Fund.
  - Authorities expect additional non-concessional external borrowing through end-2013.
- Domestic public debt accumulation accelerated since 2008 as external financing fell:
  - In 2009 debt with the MMA represented 46 percent of central government domestic debt.
  - Deficit monetization halted in September 2009; replaced by T-bill and bond sales mainly to commercial banks; outstanding MMA stock converted into negotiable bonds.

### Quantitative breakdown (selected figures from Table 1 and narrative)
- Total PPG debt by year (percent of GDP): 2004: 55.2; 2005: 64.9; 2006: 62.9; 2007: 66.3; 2008: 68.6; 2009: 85.6; 2010: 88.7.
- PPG external (percent of GDP): 2004: 40.1; 2005: 41.3; 2006: 39.6; 2007: 39.8; 2008: 37.4; 2009: 41.8; 2010: 41.8.
- PPG domestic (percent of GDP): 2004: 15.1; 2005: 23.6; 2006: 23.4; 2007: 26.4; 2008: 31.2; 2009: 43.9; 2010: 46.9.
- MMA share of PPG domestic (percent of GDP): 2004: 8.4; 2005: 13.3; 2006: 8.3; 2007: 6.7; 2008: 16.4; 2009: 20.3; 2010: 14.5.
- Debt service (total PPG debt service, percent of GDP): 2004: 7.9; 2005: 7.1; 2006: 7.3; 2007: 7.3; 2008: 10.9; 2009: 10.9; 2010: 13.1.

### Private external debt and aggregate external exposure
- Private external debt rose to almost 43 percent of GDP in 2010 (a small increase over 2008).
- About one third of private external debt is short-term.
- Combined private external debt and total public debt ≈ 132 percent of GDP.
- External debt (PPG + private) ≈ 85 percent of GDP in 2010.
- External debt represented about 150 percent of goods and services exports in 2010 (Table 2).
- By end-2010, gross reserves were sufficient to cover short-term debt but reserves trended downward; temporary boosts included $74 million in November 2010 from Male airport privatization.
- Total PPG debt rose to 2.5 times total central government revenue, from under 1.2 times three years earlier.

### Selected vulnerability indicators (Table 2, 2007–2010)
- Total external debt (PPG + private) in percent of GNFS domestic exports: 2007: 113.3; 2008: 115.2; 2009: 141.3; 2010: 149.6.
- Total external debt (PPG + private) in percent of Total Revenue: 2007: 145.7; 2008: 168.5; 2009: 219.9; 2010: 239.3.
- Total short-term external debt (PPG + private) in percent of gross reserves: 2007: 60.8; 2008: 89.9; 2009: 69.2; 2010: 63.2.
- Total PPG debt in percent of GNFS domestic exports: 2007: 92.3; 2008: 102.1; 2009: 153.4; 2010: 156.2.
- Total PPG debt in percent of total revenue: 2007: 118.7; 2008: 149.2; 2009: 238.8; 2010: 249.9.

### Macroeconomic context and baseline assumptions (Box 1)
- Real GDP growth: projected average 4.4 percent a year in 2010–15; growth was -2.3 percent in 2009; expected to average 4.5 percent from 2016.
- Inflation: projected around 4 percent a year in 2010–15; expected to stay at 3 percent from 2016.
- Interest rates on public debt: assumed to increase to 7.3 percent by 2016 and remain at that level thereafter (compared with an average of 3.4 percent over the previous six years).
- External current account deficit (including grants): projected to average about 36.4 percent of GDP per year in 2010–15 and to rise to about 55 percent of GDP in 2030.
- Gross reserves: assumed fully depleted by 2013 under the baseline; become negative thereafter, implying an unmet financing gap cumulatively reaching 131 percent of GDP by 2030.
- Fiscal deficit (including grants): projected to decline to 17.9 percent of GDP in 2010 from 29 percent in 2009; expected to remain elevated through 2013 and to rise slowly thereafter reaching about 38 percent of GDP in 2030.
- Financing assumptions: through 2016 domestic financing acts as residual; from 2017 domestic borrowing kept constant at 8 percent of GDP per year and external financing acts as residual; new annual PPG external borrowing would average over 26 percent of GDP from 2017–2030 (compared with averaging 4 percent from 1998–2009).
- Debt service: projected to rise from 18 percent of government revenues (and grants) in 2010 to 76 percent by 2030.

### External debt sustainability (results)
- Baseline: PPG external debt worsens through 2030, breaching external debt stock burden thresholds; PV of external debt to GDP breaches its threshold in 2010; debt-to-exports and debt-to-revenue ratios breach thresholds in the future; debt service ratios rise but remain below thresholds.
- Rescheduling note: one India loan was rescheduled, mitigating some short-term liquidity concerns.

### Stress tests and alternative scenarios
- Key vulnerabilities identified by stress tests:
  - Combination shock (one standard deviation to growth, exports, GDP deflator, non-debt flows) has the largest short-term impact on PV debt-to-GDP and debt-to-revenue ratios; the export shock is the greatest factor in that combination.
  - Interest rate shock (2 percentage points increase on new borrowing) has the largest long-term impact on debt ratios.
  - Export shock yields the most extreme impact on debt-to-exports and debt service-to-exports ratios.
  - Debt service-to-revenue ratio most affected by combination shock.
- Historical scenario: with key macro variables set to historical averages, PV external PPG debt-to-GDP breaches threshold only in the long run; other indicators remain below thresholds.
- Private external debt increases risk: private external debt > 50 percent of total external debt-to-GDP; much has maturities <10 years, market interest rates, denominated in U.S. dollars; historical underestimation risk due to reclassification of non-FDI external inflows.

### Public debt sustainability (results)
- Baseline: PV of public debt-to-GDP projected to rise from 88 percent in 2010 to 306 percent by 2030.
- PV of public debt-to-revenue (including grants) projected to rise from 248 percent in 2010 to 794 percent by 2030.
- Public debt service-to-revenue ratio projected to increase from 19 percent in 2010 to 76 percent by 2030.
- Stress tests: debt path highly vulnerable to long-term growth shocks; a permanent one standard deviation drop in real GDP growth would raise the debt ratio to 501 percent of GDP by 2030.
- Illustrative adjustment scenario reduces public debt steadily but remains vulnerable to shocks, particularly growth shocks.

### Illustrative fiscal adjustment scenario (paragraph 13)
- Additional measures beyond baseline:
  - Significant public sector redundancies.
  - Tightening of capital and operating expenditures over 2011–13.
  - Introduction by July 2011 of excises on a number of goods.
  - Revision to the Tourism Goods and Services Tax so that the tax rate rises to 6 percent when the tourism bed tax expires at end-2013.
- Under this scenario external debt burden indicators decline steadily and would only temporarily breach the PV of debt-to-GDP ratio, but remain vulnerable to combination or export shocks.

### Conclusions and policy implications
- Under current policies (baseline), Maldives’ public debt and external debt trajectories are unsustainable and the risk of external public debt distress is high.
- Four of five external debt burden indicators breached thresholds in the baseline.
- Key sources of vulnerability:
  - Severe fiscal and current account imbalances driven by expansionary fiscal stance and insufficient adjustment.
  - High exposure to tourism-sector shocks.
  - Rising private external debt with short maturities and dollar denomination, potentially underestimated.
  - Sensitivity to higher external financing costs.
- Policy needs emphasized:
  - Strong and sustained fiscal consolidation in the near term.
  - Measures to reduce wage and employment-related fiscal pressures (public sector redundancies and employment restructuring).
  - Tightening of capital and operating expenditures.
  - Tax policy reforms and timely implementation (GST on tourism, business profit tax, general GST).
  - Economic diversification where feasible to reduce tourism concentration risk.
- Without significant fiscal consolidation, public and external debt will remain on an unsustainable trajectory and financing needs over the long run would be implausible to meet.

*Source: IMF staff Debt Sustainability Analysis chapter for Maldives (extracted content).*

### 17.      Authorities’ views. The authorities are more optimistic than staff about the outlook

### _cr11293 - 17.      Authorities’ views. The authorities are more optimistic than staff about the outlook

### Authorities’ assessment
- Authorities expect stronger fiscal revenue outcomes, including from the tourism GST and the business profit tax, and are confident they can keep expenditure subdued.
- Authorities noted a rebasing of national accounts, at a very advanced stage, that will likely lead to a significant upward revision in GDP.
- Authorities nonetheless agree with staff that the current fiscal and debt trajectories are unsustainable.
- Authorities have committed to further discussions with staff aimed at exploring ways to bring the fiscal deficit back to a sustainable path.

### Staff findings on external and public debt sustainability
- External debt (nominal) series (by year): 81.3; 77.4; 78.9; 84.9; 92.3; 97.1; 108.1; 117.6; 125.8; 184.8; 324.0.
- Public and publicly guaranteed (PPG) external component (series): 39.8; 37.4; 41.8; 41.8; 44.9; 46.4; 51.2; 54.5; 57.1; 111.9; 259.7.
- Gross financing need (Millions of U.S. dollars): 503.4; 777.8; 597.6; 577.8; 768.3; 880.4; 981.8; 1127.3; 1282.4; 1881.3; 4927.5.
- Nominal GDP (Millions of US dollars) series: 1054.4; 1260.2; 1318.7; 1471.5; 1613.8; 1759.2; 1898.7; 2044.7; 2200.9; 3179.5; 6635.8.
- Key macro assumptions (selected):
  - Real GDP growth (in percent): 7.2; 6.2; -2.3; 5.7; 6.3; 4.8; 4.0; 4.1; 4.5; 4.6; 4.5; 4.4; 4.5; 4.5; 4.5.
  - GDP deflator in US dollar terms (change in percent): 7.4; 12.6; 7.1; 2.8; 5.1; 6.5; 5.5; 4.8; 3.3; 3.0; 3.0; 4.3; 3.0; 3.0; 3.0.
  - Effective interest rate (percent): 8.8; 4.6; 3.3; 4.2; 2.0; 4.5; 5.3; 5.3; 5.7; 5.8; 5.8; 5.4; 4.3; 2.9; 4.0.
- Government revenues (excluding grants, in percent of GDP) series: 48.1; 42.8; 31.4; 32.8; 38.7; 41.6; 41.1; 37.8; 37.5; 38.1; 38.1; 38.1.
- Aid flows (Millions of US dollars) (o/w Grants): 128.6 (81.6); 64.4 (40.4); 58.9 (58.9); 40.2 (40.2); 11.2 (11.2); 11.2 (11.2); 11.3 (11.3); 14.3 (14.3); 13.2 (13.2); 12.7 (12.7); 26.5 (26.5).
- Staff note: from 2013, gross international reserves are projected to be depleted and become negative, implying an external financing gap.

### Key public-debt indicators and trajectories highlighted by staff
- Public sector debt (in percent of GDP) series (selected): 66.3; 68.6; 85.6; 88.7; 95.6; 106.8; 115.2; 125.7; 137.0; 207.2; 364.9.
- PV of public sector debt (in percent of GDP) series (selected): 26.4; 31.2; 86.0; 87.8; 92.8; 102.9; 109.2; 117.7; 127.2; 181.1; 306.2.
- PV of PPG external debt (in Millions of US dollars) series: 555.8; 602.8; 679.5; 746.8; 856.6; 950.9; 1040.0; 2725.9; 13338.4.
- PV of PPG external debt (in percent of GDP) series (selected): ...; ...; 42.1; 41.0; 42.1; 42.4; 45.1; 46.5; 47.3; 85.7; 201.0.
- PV of PPG external debt (in percent of exports) series (selected): ...; ...; 67.1; 63.2; 63.2; 62.2; 65.5; 66.8; 67.6; 111.4; 258.8.
- Debt service-to-exports ratio (in percent) series (selected): 10.8; 10.2; 13.3; 13.4; 15.6; 14.9; 14.6; 13.8; 15.2; 11.8; 21.3.
- PPG debt service-to-revenue ratio (in percent) series (selected): 7.8; 9.2; 12.1; 11.3; 12.9; 11.4; 11.0; 14.6; 16.7; 12.8; 33.6.
- PV of public sector debt-to-revenue and grants ratio (in percent) series (selected): 47.4; 67.9; 239.9; 247.5; 235.7; 243.7; 261.6; 305.3; 334.1; 469.7; 794.3.
- Debt service-to-revenue and grants ratio (in percent) series (selected): 8.0; 9.7; 18.6; 18.7; 20.2; 19.5; 20.5; 28.1; 35.0; 39.7; 75.6.

### Stress-test and scenario highlights
- Baseline and stress projections for PV of debt-to-GDP ratio (selected): baseline values rise to 201 by 2030 for PPG external debt indicators; alternative scenarios and bound tests produce substantially higher ratios (examples in sensitivity tables show 2020 and 2030 peaks under shocks).
- Table summaries indicate extreme vulnerability under shocks: values for PV of debt-to-revenue and PV of debt-to-exports rise markedly across stress tests (e.g., PV of PPG external debt in percent of government revenues reaches 526.9 in one series).
- Memo item: Grant element assumed on residual financing is 22 (percent) across scenarios presented.

### Policy implications and commitments
- Staff and authorities concur that current fiscal and debt paths are unsustainable and require corrective action.
- The authorities committed to further discussions with IMF staff to explore options to restore fiscal sustainability and address the projected external financing gap resulting from reserve depletion projected from 2013.
- Implicit policy levers in the DSA include revenue mobilization (noting authorities’ confidence in tourism GST and business profit tax yields), expenditure restraint, and adjustments to borrowing terms and composition to mitigate vulnerability shown in stress tests.

*Sources: Maldivian authorities; and staff estimates and projections.*

### 1. In light of recent global developments, the January World Economic Outlook update

### 1. In light of recent global developments, the January World Economic Outlook update

### Baseline revisions and macroeconomic implications
- The January World Economic Outlook update revised up the baseline projections for international commodity prices in 2011 and beyond.
- For Maldives, the revision is expected to result in:
  - somewhat higher inflation;
  - a slightly wider current account deficit;
  - a weaker reserve path;
  - more moderate real GDP growth in 2011 than envisaged in the staff report;
  - additional pressures on the exchange rate peg.
- The update heightens the urgency of implementing the comprehensive adjustment measures recommended in the staff appraisal.

### Fiscal developments and outturns
- Authorities are revising the 2010 fiscal outturn data.
- Preliminary 2010 revenue and expenditure information points to a 2010 fiscal deficit that is likely to be at least 2 percentage points of GDP larger than envisaged in the staff report, mainly due to lower revenue from resort leases.
- Preliminary data put the 2010 fiscal deficit at around 17¾ percent of GDP, down from 29 percent in 2009, although financing information points to a deficit of around 20-21 percent of GDP.
- The authorities state tax measures adopted in 2010 will have a future annual yield of 7½ percent of GDP.
- A deficit of 15 percent of GDP in 2011 is expected under current policies (authorities’ projection).
- Staff supplement suggests the December 2010 fiscal target may have been missed by 2 percent of GDP, though final outcomes remain uncertain pending end-of-year reconciliation.

### National accounts and data timing
- The rebasing of the national accounts is ongoing; revised figures are now expected to be published in March 2011.

### Political developments
- Maldives held its first ever local government elections on February 5 to elect a total of 1,091 councilors at the city, island, and atoll levels.
- Elections were orderly with high voter turnout.
- Preliminary reports: DRP won 502 seats; MDP won 375 seats.
- DRP took control of a majority of island and atoll councils; MDP won a significant majority in major population centers, including Male and Addu.

### Recent macroeconomic performance and outlook
- After contracting by 2¼ percent in 2009, the economy rebounded strongly in 2010; real GDP growth is estimated at 4¾ percent in 2010.
- Inflation is driven mainly by international commodity prices and is expected to average 5 percent in 2010.
- The current account deficit is projected to have widened to about 32¼ percent of GDP in 2010.
- Over the medium term, economic activity is likely to stabilize and grow in line with global developments.
- Tourism is likely to remain the main engine of growth in the medium term.

### Monetary policy, reserves, and exchange rate
- Monetary policy has helped stabilize the economy: active open market operations and cessation of deficit monetization reduced excess rufiyaa liquidity.
- Private sector credit stalled; bank investments in treasury bills pushed up aggregate credit and broad money growth.
- International reserves remain on a downward path, interrupted by temporary external financing injections.
- MMA continues to ration foreign exchange supply to banks while fully meeting demand from the central government and some state-owned enterprises; dollar shortages persist and the parallel market premium has increased somewhat.
- The real effective exchange rate (REER) has appreciated since mid-2008, broadly tracking movements in the US dollar, posing competitiveness challenges.
- Directors endorsed the tight policy stance of the MMA and recommended continued monetary tightening to safeguard price stability, stem reserve losses and contain currency pressures.
- Authorities agreed to increase the frequency of open market operations, introduce two-week reverse repos beginning February 14 to supplement existing 1 week reverse repos, and may consider increasing the minimum reserve requirement (currently at 25 percent).

### Financial sector condition and measures
- Banking system broadly well capitalized but vulnerabilities remain: non-performing loans have continued to increase due to exposure to large tourism-related borrowers, affecting profitability.
- Banks have become significantly exposed to the sovereign.
- MMA reached agreement with banks on compliance with regulations on single borrower limits, asset classification and provisioning, and foreign currency exposure limits by end-2011.
- Directors emphasized continued enforcement of prudential regulations, particularly on provisioning, single borrower limits, and foreign currency exposure limits, and strengthening the AML/CFT framework.
- Authorities intend to privatize the largest public bank by engaging a strategic investor.
- Banks hold long positions in dollars and only 25 percent of loans are extended to non-tradeable sectors.

### Executive Board assessment and policy recommendations
- Directors noted the recovery fueled by tourism but stressed the economy faces unsustainable fiscal and external positions.
- Urgent need for decisive and comprehensive adjustment measures to achieve macroeconomic stability, sustainable growth and poverty reduction.
- Recommended policy mix:
  - continued and credible fiscal adjustment through additional revenue-enhancing, expenditure-reducing, and expenditure-targeting measures;
  - strengthening public financial management;
  - continued monetary tightening to safeguard price stability and stem reserve losses;
  - enforcement of prudential banking regulations and strengthening AML/CFT framework;
  - close policy dialogue to reach agreement on a strong, medium-term adjustment strategy, including credible and realistic prior actions, as a basis for completing the second review under the program.
- Directors observed the fixed exchange rate regime has served as an effective nominal anchor but noted steady reserve pressures and persistent dollar shortages; they called for continued discussions on exchange rate policy while being mindful of risks and impact on the poor.

### Staff and authorities’ views on exchange rate adjustment
- Staff argue fiscal measures would need to be supplemented by a significant exchange rate adjustment to restore fiscal and external sustainability; this precludes the smoother adjustment path preferred by authorities.
- Appendix 1 estimate (as cited): net effect of a 25 percent devaluation on the fiscal position is an improvement of 1.7 percent of GDP assuming a wage freeze, and a deterioration equivalent to 2.4 percent of GDP with constant real wages—highlighting risks of relying on devaluation to strengthen fiscal position.

### Selected economic indicators and key statistics (2006–12)
- Population (in 1,000; 2009 est.): 315
- GDP per capita (in U.S. dollars; 2009 est.): 4,189
- Quota (in million SDRs): 8.2

Output and prices (Annual percentage change)
- Real GDP: 2006: 18.0; 2007: 7.2; 2008: 6.2; 2009: -2.3; 2010 Est.: 4.8; 2011 Proj.: 4.0; 2012 Proj.: 4.1
- Inflation (end-of-period): 2006: 3.1; 2007: 10.3; 2008: 9.1; 2009: 4.0; 2010 Est.: 5.0; 2011 Proj.: 6.0; 2012 Proj.: 3.5
- Inflation (period average): 2006: 3.5; 2007: 7.4; 2008: 12.3; 2009: 4.0; 2010 Est.: 5.0; 2011 Proj.: 5.5; 2012 Proj.: 4.8
- GDP deflator: 2006: 3.5; 2007: 7.4; 2008: 12.6; 2009: 7.1; 2010 Est.: 6.5; 2011 Proj.: 5.5; 2012 Proj.: 4.8

Central government finances (In percent of GDP)
- Revenue and grants: 2006: 52.1; 2007: 55.8; 2008: 46.0; 2009: 35.9; 2010 Est.: 35.5; 2011 Proj.: 39.4; 2012 Proj.: 42.3
- Expenditure and net lending: 2006: 59.4; 2007: 61.4; 2008: 63.1; 2009: 64.9; 2010 Est.: 53.4; 2011 Proj.: 60.7; 2012 Proj.: 61.1
- Overall balance: 2006: -7.3; 2007: -5.5; 2008: -17.1; 2009: -29.0; 2010 Est.: -17.9; 2011 Proj.: -21.3; 2012 Proj.: -18.8
- Overall balance excl. grants: 2006: -14.7; 2007: -13.3; 2008: -20.3; 2009: -33.5; 2010 Est.: -20.7; 2011 Proj.: -22.0; 2012 Proj.: -19.4
- Financing: 2006: 7.3; 2007: 5.5; 2008: 17.1; 2009: 29.0; 2010 Est.: 17.9; 2011 Proj.: 21.3; 2012 Proj.: 18.8
- Foreign financing: 2006: 4.5; 2007: 4.6; 2008: 4.6; 2009: 8.4; 2010 Est.: 10.3; 2011 Proj.: 9.6; 2012 Proj.: 4.6
- Domestic financing: 2006: 2.8; 2007: 1.0; 2008: 12.5; 2009: 20.6; 2010 Est.: 7.6; 2011 Proj.: 11.7; 2012 Proj.: 14.2
- Public and publicly guaranteed debt: 2006: 62.9; 2007: 66.3; 2008: 68.6; 2009: 85.0; 2010 Est.: 87.6; 2011 Proj.: 91.7; 2012 Proj.: 101.8
  - Domestic: 2006: 23.4; 2007: 26.4; 2008: 31.2; 2009: 43.9; 2010 Est.: 46.9; 2011 Proj.: 50.6; 2012 Proj.: 60.4
  - External (excl. IMF and currency swaps by MMA): 2006: 39.6; 2007: 39.8; 2008: 37.4; 2009: 41.2; 2010 Est.: 40.7; 2011 Proj.: 41.1; 2012 Proj.: 41.4

Monetary accounts (Annual percentage change)
- Broad money: 2006: 18.9; 2007: 24.1; 2008: 21.8; 2009: 12.5; 2010 Est.: 16.8; 2011 Proj.: -6.0; 2012 Proj.: ...
- Domestic credit: 2006: 38.6; 2007: 44.7; 2008: 35.2; 2009: 14.0; 2010 Est.: 4.9; 2011 Proj.: -0.9; 2012 Proj.: ...
- Of which: To private sector: 2006: 48.6; 2007: 49.4; 2008: 29.7; 2009: -4.1; 2010 Est.: -2.5; 2011 Proj.: -6.2; 2012 Proj.: ...

Balance of payments (In percent of GDP, unless otherwise indicated)
- Current account: 2006: -33.0; 2007: -41.5; 2008: -51.4; 2009: -30.9; 2010 Est.: -32.3; 2011 Proj.: -37.1; 2012 Proj.: -35.6
- Exports: 2006: 24.6; 2007: 21.6; 2008: 26.2; 2009: 12.8; 2010 Est.: 12.2; 2011 Proj.: 11.7; 2012 Proj.: 11.6
- Imports: 2006: -89.1; 2007: -91.5; 2008: -96.9; 2009: -64.6; 2010 Est.: -67.4; 2011 Proj.: -75.0; 2012 Proj.: -73.4
- Nonfactor services, net: 2006: 35.0; 2007: 36.0; 2008: 29.4; 2009: 28.3; 2010 Est.: 31.3; 2011 Proj.: 35.4; 2012 Proj.: 38.0
- Capital and financial account (incl. e&o): 2006: 37.9; 2007: 48.8; 2008: 46.0; 2009: 32.1; 2010 Est.: 37.9; 2011 Proj.: 26.5; 2012 Proj.: 23.3
  - General government, net: 2006: 4.2; 2007: 3.4; 2008: 5.3; 2009: 5.5; 2010 Est.: 1.9; 2011 Proj.: 2.3; 2012 Proj.: 3.7
  - Banks and other sectors, net: 2006: 14.9; 2007: 21.1; 2008: 14.4; 2009: 8.5; 2010 Est.: 16.2; 2011 Proj.: 13.7; 2012 Proj.: 7.9
- Overall balance: 2006: 4.9; 2007: 7.3; 2008: -5.4; 2009: 1.2; 2010 Est.: 5.6; 2011 Proj.: -10.5; 2012 Proj.: -12.3
- Gross international reserves (in millions of US$; e.o.p.) 1/: 2006: 232; 2007: 310; 2008: 241; 2009: 262; 2010 Est.: 351; 2011 Proj.: 254; 2012 Proj.: 65
- In months of GNFS imports: 2006: 2.7; 2007: 3.0; 2008: 1.8; 2009: 2.8; 2010 Est.: 3.2; 2011 Proj.: 2.0; 2012 Proj.: 0.5
- In percent of short-term debt at remaining maturity: 2006: 149; 2007: 117; 2008: 80; 2009: 97; 2010 Est.: 105; 2011 Proj.: 67; 2012 Proj.: 15
- External debt 2/: 2006: 66; 2007: 81; 2008: 77; 2009: 79; 2010 Est.: 85; 2011 Proj.: 92; 2012 Proj.: 97
  - Medium- and long-term: 2006: 55; 2007: 63; 2008: 60; 2009: 65; 2010 Est.: 70; 2011 Proj.: 76; 2012 Proj.: 79
  - Short-term: 2006: 11; 2007: 18; 2008: 17; 2009: 14; 2010 Est.: 15; 2011 Proj.: 17; 2012 Proj.: 18
- External debt service (in percent of domestic GNFS exports): 2006: 9; 2007: 13; 2008: 13; 2009: 15; 2010 Est.: 15; 2011 Proj.: 18; 2012 Proj.: 17

Memorandum items
- GDP (in millions of rufyiaa): 2006: 11,717; 2007: 13,496; 2008: 16,131; 2009: 16,879; 2010 Est.: 18,835; 2011 Proj.: 20,656; 2012 Proj.: 22,518

*Source: IMF staff report and Executive Board discussion (February 14, 2011).*

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