## _cr1316 ## Source details **Canonical URL:** [_cr1316](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1316.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1316.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1316.pdf.json) --- ### Introduction and Overview - FSM highly dependent on external aid, mainly from the United States; new Compact effective since FY2004 provides funding for infrastructure and administrative expenses, with transfers steadily declining and ceasing in FY2023. - After FY2023, FSM expected to complement domestic revenues with income from its Compact Trust Fund (CTF) and other savings. - Unused infrastructure grants: about $44 million (15 percent of GDP), excluding another $28 million (10 percent of GDP) returned to the pool after cancellation or underruns. - U.S. dollar is the official legal tender. - Key challenges: - Expiry of Compact grants in FY2023 threatens continuation of public services at current levels. - Remoteness, small scale, outward migration to the United States, absence of monetary policy, and large medium-term fiscal adjustment needed. - Policy priority: fiscal and structural reforms to secure fiscal sustainability, boost potential growth, and create policy space. ### Recent Economic Developments and Outlook - Growth and inflation: - Real GDP (year-on-year changes): FY2009 1.0; FY2010 2.5; FY2011 2.1; FY2012 1.4; FY2013 0.8. - Consumer price index: FY2009 7.8; FY2010 6.3; FY2011 4.6; FY2012 5.6; FY2013 4.2. - Post-recession growth driven by construction and fisheries; public sector about 40 percent of GDP (including public enterprises). - Fiscal and external position: - Consolidated fiscal balance (in percent of GDP): FY2009 1.6; FY2010 0.5; FY2011 0.6; FY2012 1.2; FY2013 0.8. - FY2011 consolidated fiscal balance: $1.9 million (0.6 percent of GDP) surplus. - Gross public debt: $87.1 million (below 30 percent of GDP) in FY2011. - CTF assets: $257 million (83 percent of GDP) as of end-FY2012. - Current account deficit averaged 18 percent of GDP for FY2009–11; majority financed through capital transfers from official sources (12 percent of GDP). - Trade and services deficit: 61 percent of GDP; income and transfer surplus from Compact current grants and remittances: 43 percent of GDP. - Gross international reserves about 3½ months of imports. - Financial sector: - Deposit rates around 1 percent; loan rates about 14 percent for consumer loans and about 7 percent for commercial loans. - Consumer loans to household income ratio: about 24 percent in 2011. - Low loan-to-deposit ratio: 33 percent at end-FY2011; nonperforming loans just over 3½ percent. - Outlook and risks: - FY2012 estimated growth: 1.4 percent. - Staff medium-term growth expectation: about ½ percent. - FY2012 modest consolidated fiscal surplus expected: 1¼ percent of GDP, driven by a $7.6 million (2½ percent of GDP) increase in fishing access fee revenue. - Risks skewed to the downside; long-term risks include failure to prepare for Compact expiry, continued outward migration, climate change, and shore erosion. - Policy note: strengthen fiscal policy space; promote domestic food supply to mitigate commodity price shocks. ### Authorities’ Views - Authorities generally agreed with staff projections and downside risk assessment. - Fishing fees acknowledged as valuable revenue but insufficient for private sector employment. - Authorities formed the 2023 Planning Committee (presidential intention announced March 2012); approval and budget for the Committee remain urgent. ### Fiscal Policy — Sustainability Assessment and Institutional Response - CTF performance and concern: - CTF assets insufficient for long-term budget self-reliance; projected CTF investment returns in FY2024 will fall short of Compact grants to be replaced by as much as $16 million in FY2011 prices (about 5 percent of GDP). - Guiding principles for the 2023 Planning Committee: - Realistic macroeconomic framework covering general government and contingent liabilities. - Balanced fiscal adjustment path: based on a 6 percent rate of return, financial assets of $1.1 billion in FY2023 (in FY2011 prices) required for self-sufficiency. - Build policy buffers: allocate part of expenditures to an emergency transfer program recoverable within limited years. - Secure buy-in of public and state governments; continuous enhancement of audits. - Immediate fiscal measures: - Prepare expenditure reforms immediately with focus on containing the public wage bill. - Improve operational efficiency of current and capital expenditures via better planning and coordination. - Public wage rates on average 2.1 times higher than private sector; public enterprises’ wages 2.8 times higher than private sector—indicating scope to reduce wages as share of GDP. ### Tax Reform and Revenue - Planned tax reform package: - Bills to create Unified Revenue Authority (URA) and introduce a net profits tax (effective October 2013) and a value added tax (effective October 2014) in lieu of gross revenue and state sales taxes approved by national government and two out of four states; will not take effect until approved by all states. - PFTAC preliminary estimate: planned tax reform could improve tax revenue by about 4 percent of GDP. - Policy recommendations: - National government should engage remaining state governments and the public for swift consideration. - Strengthen tax administration via staff training and IT upgrades. - Devise a fiscal rule requiring fiscal surpluses to be transferred to the CTF; strengthen fiscal discipline at state level (including rules on expenditure carry-over). ### Social Security, Public Enterprises, and Fiscal Risks - Social security: - Employer/employee contributions at 7 percent each (raised from 6 percent in 2010) and scheduled increase to 7.5 percent in 2013. - 2011 outcome: total benefit payments $17.4 million in excess of total contributions $16.6 million. - Increase to 7.5 percent unlikely to halt erosion of assets permanently; further reforms of benefit structure and tax collection recommended; general budget contributions likely needed. - Public enterprises: - Account for 8.6 percent of GDP. - Utilities and other providers pose contingent liabilities; recommendation to strengthen oversight and accountability, particularly in electricity and telecommunication. - Authorities’ tacit adjustment considerations: - Authorities considered expenditure cuts of 6 percent every three years, totaling around 20 percent, to accommodate Compact reduction. ### External Stability and Exchange Rate - Real effective exchange rate: - Appreciated by 9 percent in FY2009; remained at an appreciated level due to higher inflation than trading partners. - External balance: - Large current account deficit financed through foreign assistance; Compact-related flows main determinant and will provide stable funding over the next decade. - External debt expected to decline in terms of GDP. - Policy note: use of U.S. dollar appropriate given small size and close links with the United States. ### Private Sector and Structural Reforms - Economic structure shares: - Public sector 38 percent; Private sector 22 percent; Household 31 percent. - Key bottlenecks: - Secure long-term land leases, single high-priced carrier, poor infrastructure, lack of skilled labor, crowding out by some public enterprises. - Recommendations: - Accelerate infrastructure investments; address land lease and investor approval procedures; commit long-term government support for College of the FSM; keep public wages in check; advance public enterprise reform. - Development Partners Forum momentum should lead to concrete action plans. ### Financial Sector Details and Recommendations - Banking sector: - Well capitalized with sufficient liquidity; low loan-to-deposit ratio and majority of deposits invested overseas. - Interest rates (percent, average for FY): Consumer loans FY2008 14.4; FY2009 15.4; FY2010 15.1; FY2011 14.4; FY2012 Est. 15.0; FY2013 Proj. 14.8. Commercial loans FY2008 8.5; FY2009 7.4; FY2010 6.6; FY2011 6.6; FY2012 Est. 8.1; FY2013 Proj. 7.7. - FSM Development Bank: - Continues consumer lending despite mandate for high priority projects; lacks sufficient risk assessment and provisioning. - Recommendation: return to mandate to foster new businesses; subject Development Bank and credit unions to appropriate supervision. - Insurance and supervision: - Strengthen regulatory and supervisory capacity for captive insurance activities. - Legislative actions: - Banking commission preparing draft bill on regulation and supervision of credit unions. ### Data, Statistics, and Statistical Issues - Data shortcomings significant, especially in government finance and balance of payments. - CPI: quarterly CPI rebased to Q2 2008; data lags prevent timely evaluation (FY2012 CPI not finalized). - Government finance: fiscal data not presented in GFSM 2001 format; accuracy and timeliness need improvement. - Monetary statistics: Banking Commissioner reports monthly data with two- to three-month lag; perceived legal constraints on sharing data. - Balance of payments: workers’ remittances data highly incomplete; SBOC aims to produce quarterly BOP and introduce new data sources. - Table of key macro statistics (selected): - Nominal GDP (FY2012): US$327 million. - Population (FY2012): 102,704. - GDP per capita (FY2012): US$3,185. - Compact Trust Fund (millions of U.S. dollars), FY2008–13: 119.1, 138.3, 177.2, 198.5, 257.4, 297.5. - Consolidated government finance (percent of GDP), FY2008–13: - Revenue and grants: 57.3, 65.9, 68.2, 65.9, 65.2, 62.6. - Grants: 36.1, 44.5, 46.3, 44.1, 42.0, 40.6. - Expenditure: 59.0, 64.2, 67.7, 65.3, 64.0, 61.8. - Overall balance: -1.7, 1.6, 0.5, 0.6, 1.2, 0.8. ### Appendix II — Long-Term Fiscal Sustainability (CTF Scenarios and Sensitivities) - Assumptions: - All amounts in Appendix II in FY2011 prices. - Assumed net investment return on CTF assets in all scenarios: 6 percent. - CTF market value end-FY2012: $257 million. - CTF asset allocation end-FY2012: U.S. equity 30 percent; non-U.S. equity 30 percent; fixed income 22 percent; real estate 7 percent; hedge fund 4 percent; private equity 8 percent. - Baseline scenario: - Medium-term fiscal surplus: around ½ percent of GDP (0.6 percent of GDP). - Projected government financial assets by end-FY2023: about $840 million (CTF $770 million; other funds about $70 million) in FY2011 dollars. - Investment income during drawdown beginning FY2024: about $50 million per year; expiring Compact grants in FY2024: $66 million; shortfall about 5 percent of FY2011 GDP. - Shortfall about 10 percent of GDP if Supplemental Education Grants discontinued after FY2023. - To avoid fiscal adjustment, net investment returns would need to remain at 7.2 percent per year until FY2023 (not recommended). - Policy adjustment scenarios (common elements): - Fortify fiscal surplus via comprehensive tax reform and cuts in wasteful current expenditures. - Structural reforms and accelerated utilization of infrastructure grants assumed to boost potential growth to about 2½ percent. - PFTAC estimate: tax reform could raise revenue by about 4 percent of GDP. - Swift adjustment scenario: - Medium-term overall fiscal balance target: 6.4 percent of GDP. - Total required adjustment compared to FY2012: 5.1 percent of GDP. - Average annual fiscal adjustment: 1.3 percent of GDP. - Mechanics: increase fiscal surpluses by about 1¼ percent of GDP per annum for four years to reach 6.4 percent of GDP in FY2016, maintain until FY2023. - Outcome: consolidated government asset stock ~ $1.1 billion by end-FY2023, generating sufficient income to offset expiring Compact grants. - Swift scenario sensitivity: - If reforms delayed by one year: required medium-term fiscal surplus becomes 7.0 percent of GDP; total required adjustment compared to FY2012: 5.8 percent; average annual fiscal adjustment: 1.4 percent of GDP. - If growth only 1½ percent instead of 2½ percent: required fiscal surplus in FY2016 under swift scenario would be 6.7 percent of GDP (higher by 0.3 percentage points). - If net investment return 5 percent instead of 6 percent: required fiscal surplus in FY2016 under swift scenario would be 12.0 percent of GDP. - Gradual adjustment scenario: - Medium-term overall fiscal balance target: 7.8 percent of GDP. - Total required adjustment compared to FY2012: 6.6 percent of GDP. - Average annual fiscal adjustment: 0.8 percent of GDP. - Mechanics: increase fiscal surpluses by 0.8 percent of GDP per annum until reaching 7.8 percent of GDP in FY2020, then maintain until FY2023. - Outcome: same expected CTF assets in FY2023 as swift scenario but requires higher overall fiscal surplus due to slower accumulation. - Key policy recommendations from Appendix II: - Implement comprehensive revenue reform (VAT, net profits tax, URA) to raise about 4 percent of GDP. - Proceed with public financial management reform in tandem. - Cut wasteful current expenditures and consider wage and salary adjustments as part of consolidation. - Public enterprise reform to reduce fiscal burdens. - Financial sector reforms to improve access to credit and secured transaction frameworks. - Strengthen statistical capacity for timely policy responses. ### Intergovernmental Fiscal Transfers and Operational Bottlenecks - Compact and other transfers financing state service delivery; at the aggregate level these grants make up over 60 percent of total allocations. - Majority of Compact funds allocated to State Governments; National Government receives 67 percent of Domestic Funds and roughly half of U.S. Federal Grants and other external assistance. - FY2013 intergovernmental allocations (US$, FY2013) — select figures: - GRAND TOTAL: 168,097,978. - Share of US grants (I-IV): 61.2. - Share of General Fund (V): 38.5. - Totals by National and State Government: National 57,117,708; Chuuk 42,838,443; Kosrae 13,265,426; Pohnpei 32,982,042; Yap 21,894,358. - Subtotal I+II+III line totals: 93,052,854; share by government: National 9.8; Chuuk 38.1; Kosrae 10.9; Pohnpei 25.4; Yap 15.8; Total 100.0. - Operational bottlenecks causing under-utilization: - Mismatches in budget calendar (Compact grant information conveyed 4–5 months into fiscal year; state budgets approved in September). - Weak monitoring and management of projects; centralized Project Management Unit lacks up-to-date information across four states. - Lack of timely fiscal data and coordination challenges. - High per-project costs relative to state size and limited spillovers complicate political agreement. ### Risk Assessment Highlights - Risk items and judgments: - Strong intensification of the Euro area crisis: Likelihood Medium; Potential impact Medium. - Global food price shock: Likelihood Low; Potential impact High. - Global oil price shock: Likelihood Low; Potential impact Medium. - Fiscal sustainability risks (declining reform momentum and political will): Likelihood High; Potential impact High. - Financial sector risks (slowdown increasing credit risks and NPLs): Likelihood Low; Potential impact Medium. ### Staff Appraisal and Policy Priorities (summary) - Medium-term growth prospects weak; construction and fisheries provide near-term support; risks on the downside. - Urgent need for a credible fiscal strategy to address revenue gap in FY2023 with guiding principles: - (i) realistic macroeconomic framework; (ii) balanced fiscal adjustment path; (iii) policy buffers; (iv) broad buy-in by public and state governments. - Accelerate passage and implementation of comprehensive tax reform; contain public sector wage growth; prepare comprehensive social security reforms; advance reforms to facilitate domestic and foreign investment; reform public enterprises; monitor credit quality and place FSM Development Bank under appropriate supervision. *Source: INTRODUCTION, Federated States of Micronesia — IMF staff report content unit _cr1316.* ### INTRODUCTION __________________________________________________________________________________ 3 ### INTRODUCTION ### Overview - The Federated States of Micronesia (FSM) is a small Pacific Island country highly dependent on external aid, mainly from the United States. - A new Compact of Free Association Agreement with the United States (“Compact”) effective since FY2004 provides funding for infrastructure expenditure and administrative expenses, but transfers to the FSM are steadily declining and ceasing in FY2023. - After FY2023, the FSM is expected to complement its domestic revenues with income from its Compact Trust Fund (CTF) and other savings. - The amended Compact tightened rules on reporting, auditing, and the use of grants; adaptation has improved implementation, but about $44 million (15 percent of GDP) in infrastructure grants remains unused, excluding another $28 million (10 percent of GDP) returned to the pool after cancellation or underruns. - The U.S. dollar is the official legal tender. ### Key Challenges Highlighted - Scheduled expiry of Compact grants in FY2023 poses a major challenge to continuation of public services at current levels. - Remoteness from major markets and small scale hinder attraction of foreign investors and retention of skilled workers. - Outward migration continues to the United States where FSM citizens can work without a visa. - Absence of monetary policy and the large fiscal adjustment needed over the medium term limit policy space to respond to external shocks. - Policy priority: fiscal and structural reforms to secure fiscal sustainability, boost potential growth, and create policy space to dampen unforeseen shocks. ### Selected Economic Indicators (as presented) - Real GDP: FY2009 1.0; FY2010 2.5; FY2011 2.1; FY2012 1.4; FY2013 0.8 (Year-on-year Changes) - Consumer price index: FY2009 7.8; FY2010 6.3; FY2011 4.6; FY2012 5.6; FY2013 4.2 - Consolidated fiscal balance (In percent of GDP): FY2009 1.6; FY2010 0.5; FY2011 0.6; FY2012 1.2; FY2013 0.8 - Current account balance (In percent of GDP): FY2009 -18.5; FY2010 -16.6; FY2011 -18.9; FY2012 -15.0; FY2013 -14.3 - Sources: FSM authorities and Fund staff estimates. Data for FY2012 are preliminary. ### RECENT ECONOMIC DEVELOPMENTS AND OUTLOOK ### Growth and Inflation - After a recession in FY2006–08, the FSM economy grew by 2–2½ percent for FY2010 and FY2011. - Expansion drivers: new construction activities (e.g., FAA-funded airport renewal projects) and growth in the fishery sector due to good fishing conditions and high prices. - Public sector remains large: 40 percent of GDP (including public enterprises). - Inflation: peaked at 7.8 percent in FY2009, declined to 4.6 percent in FY2011; last quarter of 2011 recorded a 6.5 percent year-on-year increase due to international food and fuel price rises (these compose about 46 percent of the consumption basket). - Increasing availability of consumer loans may have contributed to recent inflation pick-up. ### Fiscal and External Position - Consolidated government reported modest surpluses through FY2011 with uneven state outcomes. - FY2011 overall consolidated fiscal balance: $1.9 million (0.6 percent of GDP) surplus. - Chuuk and Yap recorded surpluses in FY2011; Kosrae and Pohnpei each recorded deficits equivalent to about 1 percent of state GDP. - Public debt and financial assets: - Gross public debt: $87.1 million (below 30 percent of GDP) in FY2011, mostly owed to the Asian Development Bank (AsDB) on concessional terms. - CTF assets: $257 million (83 percent of GDP) as of end-FY2012. - Asset accumulation in the CTF is insufficient for long-term budget self-reliance (see Appendix II). - Net assets of the social security fund declined from $42.4 million in 2010 to $40.4 million in 2011; benefit payments exceed contribution revenue. - Current account and reserves: - Current account deficit averaged 18 percent of GDP for FY2009–11; majority financed through capital transfers from official sources (12 percent of GDP). - Trade and services deficit: 61 percent of GDP; income and transfer surplus from Compact current grants and remittances: 43 percent of GDP. - Gross international reserves about 3½ months of imports. - External developments in FY2011: - Current account deficit widened due to imports (construction materials and fuels) increasing more than exports (mainly fish). - Visitor arrivals declined significantly in FY2011 to 20 percent below the FY2009 peak. - Real effective exchange rate remained at an appreciated level due to higher inflation than trading partners. ### Financial Sector Conditions - Large spreads between deposit and loan rates: deposit rates around 1 percent; loan rates about 14 percent for consumer loans and about 7 percent for commercial loans. - Constraints: high lending risks and limited availability of land as collateral. - Commercial loan growth stagnant; consumer loans increased. - Consumer loans to household income ratio: about 24 percent in 2011. ### Outlook and Risks - Near-term growth slowdown expected as private sector fails to offset declining public demand from Compact grants reduction. - FY2012 estimated growth: 1.4 percent. - FY2012 modest consolidated fiscal surplus expected: 1¼ percent of GDP, driven mainly by a $7.6 million (2½ percent of GDP) increase in fishing access fee revenue. - Medium-term growth: staff expects about ½ percent, with limited private sector growth and a decline in Compact sector grants ($0.8 million per annum before adjusting for inflation). - Risks skewed to the downside: - Upside: U.S. military base upgrading projects in Guam and possible acceleration in release of delayed infrastructure grants. - Downside: deterioration in external environment, volatile commodity prices, delays in fiscal adjustment worsening fiscal sustainability. - Long-term risks: failure to prepare for expiry of Compact grants, continued outward migration of working age population, climate change and shore erosion of limited farmland. - Policy note: strengthen fiscal policy space; in event of exogenous shocks, temporary easing/suspension of fiscal adjustment is possible if medium-term target maintained. - To mitigate commodity price shocks: consider promoting domestic food supply through commercial farming. ### AUTHORITIES’ VIEWS - Authorities generally agreed with staff projections and the view that medium-term growth prospects are diminished due to declining Compact grants and limited private sector compensation. - Authorities agreed risks to the outlook are on the downside, highlighting vulnerability to commodity price shocks. - On fisheries: authorities acknowledged fishing fees provide valuable public revenue but do not generate sufficient employment and income for the private sector. ### POLICIES TO ACHIEVE SUSTAINABLE GROWTH — FISCAL POLICY ### Sustainability Assessment - Projected government assets unlikely to generate sufficient income to replace expiring Compact grants in FY2023 (Appendix II). - Despite benign investment performance in FY2012, projected CTF investment returns in FY2024 will fall short of Compact grants to be replaced by as much as $16 million in FY2011 prices (about 5 percent of GDP). - A steady and decisive fiscal adjustment is required for long-term fiscal sustainability. ### Institutional Response - President Mori announced in March 2012 intention to establish the “2023 Planning Committee” to assess FSM finances from FY2024 onwards and develop an action plan to address the looming budgetary shortfall; timing and Congressional appropriation for the Committee remain unclear. - Draft FY2013 budget proposed a $1 million contribution to the CTF by the President; Congress did not approve this allocation. - Approval of the budget for establishing the 2023 Planning Committee is deemed urgently needed. ### Guiding Principles for the 2023 Planning Committee (four points) - Develop a realistic macroeconomic framework: - Budget documents should cover the general government (include contingent liabilities from public enterprises or social security fund). - Long-term fiscal projections should use conservative assumptions on growth and asset returns and provide an appropriate expenditure trajectory. - IMF stands ready to share its long-term fiscal projection framework to assist preparation. - Devise a balanced fiscal adjustment path: - Balance preserving assets for future generations, current development needs (e.g., infrastructure), and short-term growth implications. - Based on a 6 percent rate of return assumed in an earlier GAO study, achieving budgetary self-sufficiency requires financial assets in the CTF of $1.1 billion in FY2023 (in FY2011 prices). - This level could be achieved by increasing fiscal surplus to about 6.4 percent of GDP by FY2016 and maintaining that surplus until FY2023. - Alternatively, a more gradual accumulation of surpluses would require a higher overall fiscal surplus target and shorten time to re-adjust in event of setbacks; longer adjustment raises the risk of reform fatigue. - Fiscal consolidation growth impacts should be partly offset by accelerating structural reforms (see section C). - Build in policy buffers: - Given long implementation period, absence of monetary policy, and susceptibility to external shocks, FSM needs fiscal policy space for resilience. - Possible actions: allocate part of expenditures to fund an emergency transfer program, designed so amounts are recovered by other savings within a limited number of years once shocks subside, to avoid undermining long-term consolidation. - Secure buy-in of the public and state governments: - Broad public support and state government contributions are essential. - National government must engage stakeholders in needed fiscal reforms. - Continuous enhancement of audits and reflection of results in fiscal management are important. - Approval of a long-term fiscal reform plan should be the key deliverable of the Committee. ### Immediate Fiscal Measures - Prepare fiscal expenditure reforms immediately with focus on containing the public wage bill. - Significant savings from improving operational efficiency of current and capital expenditures through better planning and coordination between national and state governments. - Public wage rates are on average 2.1 times higher than private sector; public enterprises’ wages are 2.8 times higher than private sector. - While absolute comparability of qualifications may differ and drastic cuts risk accelerating outward migration, regional comparisons suggest scope to reduce wages as share of GDP without excessively negative economic effects. - Strengthen governance control over compensation in public enterprises to ensure wage levels are justifiable from job requirements. *Source: INTRODUCTION, Federated States of Micronesia — IMF staff report content unit _cr1316.* ### 19. In parallel, the planned comprehensive tax reform should be swiftly implemented. ### _cr1316 - 19. In parallel, the planned comprehensive tax reform should be swiftly implemented. ### Tax reform and revenue - A set of bills to create the Unified Revenue Authority (URA) and to introduce a net profits tax (effective October 2013) and a value added tax (effective October 2014) in lieu of gross revenue and state sales taxes were approved by the national government as well as two out of the four state governments, but will not take effect until they are approved by all states. - Reform objectives: - Remove the bias against industries with relatively high fixed costs. - Eliminate distortions from different tax rates across goods and services. - Make the FSM tax system more efficient. - Policy recommendation: - The national government should step up efforts to engage state governments and the general public for swift consideration of the tax reform bill in the remaining states. - Further efforts to strengthen the tax administration through staff training and upgrading of the IT system will also be necessary. ### Public sector financial management - Key needs: - Improve public sector financial management to complement and safeguard the benefits of expenditure and tax reforms. - Accelerate ongoing efforts supported by the Pacific Financial Technical Assistance Center (PFTAC). - Budget documents should reflect activities of the general government financed by domestic revenues and foreign grants as well as those of state governments. - Policy recommendations: - Devise a fiscal rule requiring fiscal surpluses to be transferred to the CTF. - Strengthen fiscal discipline at state level, including tighter fiscal rules on the expenditure carry-over between annual budgets. ### Social security system - Financing structure: - Employer/employee contributions at a rate of 7 percent each. - Funds benefit payments for old-age, surviving spouses of deceased workers, and disabled. - 2011 outcome: - Total benefit payments ($17.4 million) were in excess of total contributions ($16.6 million). - Recent and planned measures: - Contribution rate was raised from 6 to 7 percent in 2010 and will be further increased to 7.5 percent in 2013. - Assessment and recommendations: - The increase to 7.5 percent in 2013 is unlikely to halt the erosion of assets permanently. - Further reforms of the benefit structure and tax collection are needed to reverse fund deficits and reduce delinquent accounts to bring the system into long-term sustainability. - Given time needed for comprehensive reforms, contributions from the general budget will likely be needed to protect the value of the social security fund. ### Public enterprises and fiscal risks - Public enterprises account for 8.6 percent of GDP. - While budget transfers to public enterprises are currently limited, utilities and other public service providers pose considerable contingent liabilities if their financial positions deteriorate. - Recommendation: - Strengthen oversight and accountability of public enterprises, particularly in electricity and telecommunication. ### Authorities’ views (selected) - Fiscal adjustment pace: Authorities did not specify a preferred pace of fiscal adjustment; considering expenditure cuts of 6 percent every three years, totaling around 20 percent, to accommodate scheduled reduction in Compact grants. - Wage expenditure: Authorities agreed on the need to contain growth of wage expenditure but noted public and private wages are not necessarily comparable. - Policy buffer: Authorities have a separate trust fund from the CTF for natural disasters; use is limited to disaster relief and other funds are insufficient to mitigate costs such as commodity price shocks. - Social security: With contribution increase to 7.5 percent scheduled in January 2013, there are no immediate plans for improving the social security fund balance; options for comprehensive reforms will be explored while continuing support from the general budget. - Public enterprises: Operational subsidies have been significantly reduced; remaining capital subsidies are primarily used to support provision of essential services. ### External stability and exchange rate - Real effective exchange rate developments: - Appreciated by 9 percent in FY2009 due to high inflation driven by food and fuel prices and has since remained appreciated though not out of line from regional peers. - Trend expected to reverse as inflationary pressures subdue over the medium term. - External balance: - Large current account deficit is financed through foreign assistance. - Compact-related financial flows are the main determinant of external balances and will continue to provide a stable source of funding over the next decade. - External debt is expected to decline in terms of GDP. - Policy note: - Use of the U.S. dollar as the official currency is appropriate given the small size of the economy and its close financial and trade linkages with the United States. ### Private sector and structural reforms - Economy structure: - Public sector share: 38 percent. - Private sector share: 22 percent. - Household share: 31 percent. - Key bottlenecks for private sector development: - Difficulties in obtaining secure long-term land leases. - Reliance on a single carrier operating high-priced flights. - Poor infrastructure. - Lack of skilled labor. - Some public enterprises crowd out financial and human resources. - Recommendations to support private sector growth: - Accelerate infrastructure investments. - Improve business environment, including addressing land lease issues and burdensome approval procedures for foreign investment. - Commit long-term government support for the College of the FSM to train future workers. - Keep public wages in check to reduce the public-private wage gap. - Advance public enterprise reform to encourage competition and private sector participation where feasible. - Development Partners Forum: - FSM’s first Development Partners Forum held in early November provided an opportunity for stakeholders to explore paths to future growth; momentum should be followed by concrete action plans with strong stakeholder engagement. ### Financial sector - Banking sector: - Well capitalized and with sufficient liquidity. - Low loan-to-deposit ratio: 33 percent at end-FY2011. - Majority of deposits invested in safe financial assets overseas rather than lent to private sector due to lack of bankable projects. - Legislative and policy needs: - Further measures to facilitate taking immovable property as collateral are necessary to increase commercial lending. - Credit trends and risks: - Increasing availability of consumer loans may have contributed to a pick-up in inflation in recent years. - Nonperforming loans (NPLs) remain relatively low at just over 3½ percent, but careful monitoring of credit quality is warranted. - FSM Development Bank: - Continues consumer lending despite its mandate to provide loans for high priority projects. - Lacks sufficient risk assessment capacity and provisioning against consumer loans. - Recommendation: Return to mandate to foster new businesses; subject Development Bank and credit unions to appropriate supervision in line with international best practices. - Insurance: - Strengthening regulatory and supervisory capacity is a priority given increasing activities of captive insurance companies. - Authorities’ action: - Banking commission preparing a draft bill on regulation and supervision of credit unions. - Authorities generally support placing the FSM Development Bank under appropriate supervision but note significant political decisions would be required. ### Data and statistics - Ongoing efforts by the Office of Statistics, Budget and Economic Management, Overseas Development Assistance, and Compact Management (SBOC) to improve data collection and management, including efforts to release quarterly CPI data and upgrade its website. - Recommendation: - Further enrich statistics and consolidate fiscal data across national and state governments in a timely manner. ### Staff appraisal — growth, risks, and policy priorities - Growth outlook: - Medium-term growth prospects remain weak as sluggish private sector growth is insufficient to offset the scheduled decline in Compact grants. - Construction projects and fisheries expansion will provide near-term support, but risks are on the downside. - External risks: - Risks to external stability currently limited due to stable official transfers; failure to address Compact grants expiry in FY2023 would create financing difficulties. - CTF risk: - Considerable risk that the CTF would not reach the necessary level for self-sufficiency. - National and state governments should agree on realistic reform plans and start implementing them as soon as possible. - Fiscal strategy guidance: - Prepare and adopt a credible fiscal strategy to deal with the looming revenue gap in FY2023 with guiding principles: - (i) a realistic macroeconomic framework; - (ii) a balanced fiscal adjustment path; - (iii) policy buffers to guard against possible shocks; and, - (iv) broad buy-in by the public and state governments. - Fiscal reforms: - Passage of the planned comprehensive tax reform should be accelerated with increasing efforts of engaging state governments and the general public to garner their support. - Curtail public sector wage growth in addition to savings from improved operational efficiency of government expenditure. - Social security: - Urged to prepare further comprehensive measures including on system design to protect the value of the social security fund. - Structural reforms: - Advance reforms to facilitate domestic and foreign investment, including liberalizing land use and lease and streamlining investment permit procedures at national and state levels. - Reform public enterprises to improve productivity and resource use. - Pursue structural reforms through a clear nation-wide development plan in line with the Development Strategy adopted in the first Development Partners Forum. - Financial sector actions: - Monitor credit quality as consumer loans increase. - Bring FSM Development Bank under appropriate supervision and redirect it toward financing viable start-ups rather than competing with private banks on consumer loans. *FEDERATED STATES OF MICRONESIA INTERNATIONAL MONETARY FUND* ### 47. It recommended that the next Article IV consultation take place on the 24 month cycle. ### _cr1316 - 47. It recommended that the next Article IV consultation take place on the 24 month cycle. ### Fiscal arrangements and operational challenges in Compact grants utilization - Most service delivery functions (for example, health and education) are assigned to the State Governments and financed through a combination of fiscal transfers from the National Government and the States’ share in domestically generated revenue. - Key sources of fiscal transfers to the state governments: the Compact Sector Grants, the Compact Infrastructure Grant, the Compact Supplemental Education Grant, and grants made available through the U.S. Federal Program. - At the aggregate level, these grants make up for over 60 percent of total allocations; the balance is made up mainly by the FSM General Fund (comprising domestic tax and non-tax revenue). - The majority of the Compact sector grants (85 percent) and the Compact Infrastructure Grant (75 percent) is earmarked for operational and investment support for the education and health sectors. - Over 90 percent of the Compact Funds are allocated to the State Governments, while the National Government receives 67 percent of the Domestic Funds and roughly half of the U.S. Federal Grants and other external assistance. ### Operational bottlenecks and causes of delay in grants utilization - Mismatches in budget calendar: - Information on the Compact grants available for the next fiscal year is typically conveyed to state governments 4–5 months into the current fiscal year. - State legislatures typically approve the state budgets in September (end of FY), leaving little time for coordination with national and other state governments. - Weak monitoring and management of projects: - Infrastructure projects are centrally managed at Project Management Unit of the national government, but it is often a challenge to keep most updated information about prospects, estimated costs, and progress of individual projects in all four states. - Lack of timely fiscal data: - Data on fiscal activities of national and state governments in the ongoing year are not available in a timely manner. - Financial statements of the national government are submitted for audit within 6 months from the end of fiscal year, but coordination and reallocation during the fiscal year is very difficult. - Coordination problems on allocation of infrastructure grants across states: - High per-project costs relative to the size of individual states and limited economic spillovers due to large geographic distance make political agreement difficult. - Opportunity costs associated with delay and under-utilization of Compact grants are substantial; overcoming impediments could lead to significant economic and efficiency gains. ### Intergovernmental fiscal transfers and FY2013 allocations (US$, FY2013) - Population (by government): National 48,654; Chuuk 6,616; Kosrae 36,196; Pohnpei 11,377; Yap 102,843 - I. REGULAR SECTOR ("Operations") - A. Education Sector: National 4,353,841; Chuuk 9,603,527; Kosrae 2,447,446; Pohnpei 7,374,354; Yap 3,880,125; Line Totals 27,659,293 - B. Health Sector: National 895,705; Chuuk 8,608,714; Kosrae 2,111,506; Pohnpei 5,768,196; Yap 3,308,441; Line Totals 20,692,562 - C. Public Sector Capacity Building: National 0; Chuuk 1,300,506; Kosrae 502,060; Pohnpei 421,057; Yap 506,512; Line Totals 2,730,135 - D. Environment Sector: National 0; Chuuk 685,341; Kosrae 215,903; Pohnpei 447,987; Yap 364,550; Line Totals 1,713,781 - E. Private Sector Development: National 0; Chuuk 851,135; Kosrae 782,463; Pohnpei 157,000; Yap 795,663; Line Totals 2,586,260 - F. Enhanced Reporting & Accountability: National 222,450; Chuuk 619,095; Kosrae 177,582; Pohnpei 288,645; Yap 173,465; Line Totals 1,481,236 - Subtotal Operations: National 5,471,996; Chuuk 21,668,318; Kosrae 6,236,959; Pohnpei 14,457,239; Yap 9,028,756; Line Totals 56,863,268 - II. COMPACT INFRASTRUCTURE GRANT: National 2,443,795; Chuuk 9,286,422; Kosrae 2,663,737; Pohnpei 6,185,246; Yap 3,858,752; Line Totals 24,437,952 - III. SUPPLEMENTAL EDUCATION GRANT: National 1,175,163; Chuuk 4,465,620; Kosrae 1,280,928; Pohnpei 2,974,339; Yap 1,855,583; Line Totals 11,751,634 - Subtotal I+II+III: National 9,090,954; Chuuk 35,420,360; Kosrae 10,181,624; Pohnpei 23,616,824; Yap 14,743,091; Line Totals 93,052,854 - Share by Government (I+II+III): National 9.8; Chuuk 38.1; Kosrae 10.9; Pohnpei 25.4; Yap 15.8; Total 100.0 - IV. US FEDERAL PROGRAM (Federal Grants): National 4,524,810; Chuuk 682,854; Kosrae 926,259; Pohnpei 1,954,974; Yap 1,661,080; Line Totals 9,749,976 - Share by Government: National 46.4; Chuuk 7.0; Kosrae 9.5; Pohnpei 20.1; Yap 17.0; Total 100.0 - V. GENERAL FUND (Domestic Revenue): National 43,191,184; Chuuk 6,735,229; Kosrae 1,974,544; Pohnpei 7,332,640; Yap 5,490,187; Line Totals 64,723,784 - Share by Government: National 66.7; Chuuk 10.4; Kosrae 3.1; Pohnpei 11.3; Yap 8.5; Total 100.0 - VI. OTHER EXTERNAL ASSISTANCE: National 310,760; Chuuk 0; Kosrae 183,000; Pohnpei 77,604; Yap 0; Line Totals 571,364 - Share by Government: National 54.4; Chuuk 0.0; Kosrae 32.0; Pohnpei 13.6; Yap 0.0; Total 100.0 - Totals by National and State Government: National 57,117,708; Chuuk 42,838,443; Kosrae 13,265,426; Pohnpei 32,982,042; Yap 21,894,358 - Share in aggregate budget (by Government): National 34.0; Chuuk 25.5; Kosrae 7.9; Pohnpei 19.6; Yap 13.0 - GRAND TOTAL: 168,097,978 - Share of US grants (I-IV): 61.2 - Share of General Fund (V): 38.5 - Share of Other External Assistance (VI): 0.3 ### The challenge of commodity price volatility on inflation - Structural exposure: - FSM imported goods equivalent to 60 percent of GDP in 2011. - Combined share of food and fuels was just slightly below half of total imports. - Share of imported goods and services in FSM’s CPI baskets is 76.3 percent, with 30.5 percent of imported food. - Fuel prices account for 3.4 percent of total basket. - Pass-through dynamics (VAR analysis findings): - Oil price shocks are only partially passed-through with a lag of one quarter. Retail fuel price adjustments occur every four months due to the retail pricing scheme of FSM Petroleum Corporation. - Domestic food prices respond to world price shocks with a lag of about two quarters and exhibit stronger persistence. - Responses of FSM's CPI to a 1 percent shock: electricity/transportation effects and headline contributions shown in staff calculations (charts referenced). - Historical impacts: - During 2005–08, domestic inflation remained relatively muted between 4–5 percent, compared to 3–4 percent in the United States. - Inflation rose sharply to above 10 percent starting late 2008 after a shock in world prices of rice, before subsiding at the end of 2009. - Domestic prices started to edge up again in early 2010 as world commodity prices resumed upward trend and domestic demand improved. - Policy considerations to mitigate volatility impacts: - Promote domestic food supply through commercial farming. - Redesign utility price scheme for slower fuel price pass-through while avoiding undue burden on public finance. - Allow more competition in importing businesses. *Prepared with inputs by Hans van Rijn of Asian Development Bank. Source: Data provided by the FSM authorities.* ### 0.08 percent. ### _cr1316 - 0.08 percent. ### Overall buffer and macro indicators - Overall Buffer Index: Micronesia’s overall buffer to withstand shocks has remained weak. 1/ - 1/ The overall buffer index is the sum of five individual buffers normalized by their respective standard deviations during 2004–07. - Inflation: Inflation is higher in 2012 than during the pre-crisis period. - Fiscal balance: The fiscal balance in 2012 improved thanks to high fishing fees revenue. - Debt: Debt remains at a low level, though slightly above the 2004–07 average. - Current account and reserves: - The current account position, net of FDI, deteriorated in recent years, though it is sustained by a stable flow of official transfers. - Reserves have increased. ### Economic developments and growth drivers - Long-run growth: Over a longer horizon, growth has been sluggish, with some improvements in recent years. - Growth drivers: - Growth has mainly been driven by the fishery sector and public construction, the latter "not a sustainable source of growth." - Inflation and employment: - Inflation is volatile and higher than in the U.S., driven by food and commodity prices. - Private sector employment increased over the years; recent growth concentrated in fisheries and construction. ### Key macroeconomic and fiscal statistics (FY2008–13; FY = fiscal year ending September 30) - Nominal GDP (FY2012): US$327 million - Population (FY2012): 102,704 - GDP per capita (FY2012): US$3,185 - IMF Quota: SDR5.1 million - Real sector (average annual percent change unless otherwise noted), FY2008–13: - Real GDP: -2.6, 1.0, 2.5, 2.1, 1.4, 0.8 - Consumer prices: 6.6, 7.8, 6.3, 4.6, 5.6, 4.2 - Employment (Public incl. public enterprises / Private): Public: -6.3, -2.1, 1.3, -0.2, 0.1, 0.1; Private: -3.5, 1.7, 7.4, 5.0, 0.3, 0.2 - Nominal wages: 3.7, 4.2, 2.5, 0.1, 2.7, 2.7 - Public-private wage ratio: 2.1, 2.2, 2.2, 2.1, 2.1, 2.1 - Consolidated government finance (in percent of GDP), FY2008–13: - Revenue and grants: 57.3, 65.9, 68.2, 65.9, 65.2, 62.6 - Revenue: 21.2, 21.4, 21.8, 21.8, 23.3, 22.0 - Grants: 36.1, 44.5, 46.3, 44.1, 42.0, 40.6 - Expenditure: 59.0, 64.2, 67.7, 65.3, 64.0, 61.8 - Current: 50.2, 47.4, 48.1, 46.9, 46.8, 45.3 - Capital: 8.8, 16.9, 19.6, 18.4, 17.2, 16.6 - Overall balance: -1.7, 1.6, 0.5, 0.6, 1.2, 0.8 - Compact Trust Fund (millions of U.S. dollars), FY2008–13: - 119.1, 138.3, 177.2, 198.5, 257.4, 297.5 - Commercial banks (end of period; in millions of U.S. dollars), FY2008–13: - Foreign assets: 101.4, 121.5, 127.7, 143.6, 156.2, 169.8 - Loans: 49.2, 46.7, 55.7, 55.2, 60.0, 65.3 - Total deposits: 118.9, 132.5, 154.1, 166.2, 175.2, 181.8 - Interest rates (percent, average for FY), FY2008–13: - Consumer loans: 14.4, 15.4, 15.1, 14.4, 15.0, 14.8 - Commercial loans: 8.5, 7.4, 6.6, 6.6, 8.1, 7.7 - Balance of payments (in millions of U.S. dollars), FY2008–13: - Trade balance: -121.7, -128.4, -130.7, -134.2, -133.1, -130.4 - Net services and income: -27.6, -31.3, -30.1, -32.4, -24.5, -25.6 - Private and official transfers: 105.5, 108.4, 112.1, 108.0, 108.7, 107.3 - Current account including official transfers: -43.8, -51.3, -48.7, -58.6, -49.0, -48.7 - Current account (in percent of GDP): -16.7, -18.5, -16.6, -18.9, -15.0, -14.3 - Current account excluding official transfers (in millions of U.S. dollars): -142.6, -155.9, -157.2, -162.2, -153.9, -152.0 - Current account excluding official transfers (in percent of GDP): -54.6, -56.2, -53.4, -52.3, -47.0, -44.8 - Overall balance (in millions of U.S. dollars): -3.0, -1.6, -0.3, 0.9, 6.5, 0.9 - Overall balance (in percent of GDP): -1.2, -0.6, -0.1, 0.3, 2.0, 0.3 - Gross reserves (in months of imports): 2.5, 2.7, 2.8, 3.6, 3.6, 3.6 - External debt (in millions of U.S. dollars; end of period) and ratios, FY2008–13: - Stock: 74.1, 84.6, 84.3, 87.1, 87.1, 87.1 - Stock (in percent of GDP): 28.4, 30.5, 28.7, 28.1, 26.6, 25.7 - Debt service (in millions of U.S. dollars): 3.2, 3.9, 4.3, 5.0, 5.1, 5.0 - Debt service (in percent of exports of goods and services): 5.4, 6.6, 6.6, 6.9, 6.6, 6.1 - Exchange rate regime: - Real effective exchange rate (Year 2000=100): 97.5, 106.7, 108.6, 107.6, 108.1, 108.5 - Memorandum: U.S. dollar is the official currency. ### Detailed fiscal operations (selected lines, FY2008–13; in millions of U.S. dollars and percent of GDP) - Revenue and grants (millions): 149.8, 182.8, 200.5, 204.5, 213.4, 212.4 - Tax revenue (millions): 29.3, 31.7, 35.3, 37.2, 37.3, 38.0 - Wage and salary tax: 7.3, 7.1, 7.6, 7.6, 8.3, 8.9 - Gross revenue tax: 6.4, 7.8, 8.9, 9.1, 9.6, 9.8 - Import taxes: 8.4, 9.2, 10.1, 9.8, 8.1, 8.0 - Grants (from abroad, millions): 94.3, 123.5, 136.2, 136.8, 137.3, 137.8 - Current grants: 79.0, 84.4, 85.6, 84.0, 85.3, 85.6 - Capital grants: 15.4, 39.1, 50.7, 52.8, 52.1, 52.1 - Non-tax revenue (millions): 26.1, 27.6, 28.9, 30.5, 38.8, 36.6 - Fishing access revenue (millions): 17.0, 20.0, 17.7, 18.8, 26.4, 24.7 - Expenditure (millions): 154.2, 178.2, 199.1, 202.5, 209.4, 209.7 - Expense: 131.1, 131.4, 143.0, 145.6, 153.2, 153.6 - Goods and services: 127.5, 128.9, 139.1, 143.5, 151.2, 151.4 - Wages and salaries: 60.2, 63.1, 66.4, 65.9, 68.4, 69.0 - Net acquisition of nonfinancial assets: 23.1, 46.8, 56.1, 56.9, 56.2, 56.2 - Acquisition of fixed capital: 14.7, 38.0, 40.0, 38.2, 37.7, 37.7 - Gross operating balance (millions): 18.6, 51.4, 57.4, 58.9, 60.2, 58.8 - Net lending/borrowing (millions): -4.5, 4.6, 1.4, 1.9, 4.1, 2.6 - Revenue and grants (percent of GDP): 57.3, 65.9, 68.2, 65.9, 65.2, 62.6 - Expenditure (percent of GDP): 59.0, 64.2, 67.7, 65.3, 64.0, 61.8 ### Financial sector and external vulnerability indicators (FY2006–12) - Commercial banks: - Deposits (year-on-year percent change): 2.1, 5.1, -0.5, 11.4, 16.3, 7.8, 22.9 - Demand deposits (millions): 27.6, 32.8, 27.8, 31.5, 34.0, 37.6, 55.6 - Savings (millions): 51.7, 47.2, 54.1, 70.2, 88.5, 98.0, 120.8 - Time (including CDs) (millions): 34.4, 39.4, 36.4, 30.1, 30.8, 28.6, 27.3 - Loans (year-on-year percent change): 16.9, 17.7, 39.3, -5.1, 19.3, -0.9, 2.9 - Loans (percent of GDP): 11.9, 13.8, 18.8, 16.8, 18.9, 17.8, 17.4 - Foreign assets (percent of total assets): 76.3, 76.2, 68.9, 74.1, 75.1, 75.5, 77.7 - Return on assets 1/: 1.6, 1.6, 1.2, 0.7, 0.6, 0.6, ... - Equity capital 1/: 10.8, 11.1, 11.0, 10.4, 9.4, 9.1, 8.0 - Loss allowance (percent of total loans): 4.9, 4.0, 5.8, 6.2, 3.4, 3.9, 3.3 - Non-performing loans (percent): 0.9, 3.3, 6.0, 3.2, 2.5, 2.5, ... - FSM Development Bank (selected): - Loans (year-on-year percent change): 8.5, 6.2, 5.2, -5.5, 8.0, -10.7, -5.0 - Loans (percent of GDP): 9.3, 9.8, 10.1, 9.0, 9.3, 8.7, 8.2 - Foreign assets (percent of total assets): 7.1, 7.9, 7.6, 7.8, 7.0, 7.2, 9.9 - Loss allowance (percent of total loans): 21.0, 18.7, 22.3, 24.0, 25.5, 17.6, 20.6 - External indicators: - Exports (goods & services, y/y percent change): 9.2, 23.2, 5.8, -1.8, 11.9, 10.8, 6.8 - Imports (goods & services, y/y percent change): 3.4, 0.1, 14.2, 8.0, 0.4, 5.9, 1.6 - Current account balance (percent of GDP) including official transfers: -11.6, -7.3, -16.7, -18.5, -16.6, -18.9, -15.0 - Current account balance (percent of GDP) excluding official transfers: -50.9, -44.9, -54.6, -56.2, -53.4, -52.3, -47.0 - Gross official reserves (millions, data for 2012 as of end-August): 47.2, 49.5, 45.3, 53.1, 56.5, 76.8, 77.2 - Gross official reserves (months of imports): 2.9, 3.1, 2.5, 2.7, 2.8, 3.6, 3.6 - Total external debt (millions): 63.4, 65.9, 74.1, 84.6, 84.3, 87.1, 87.1 - Total external debt (percent of GDP): 25.1, 25.7, 28.4, 30.5, 28.7, 28.1, 26.6 - Debt service (millions): 2.5, 2.7, 3.2, 3.9, 4.3, 5.0, 5.1 - Debt service (percent of exports of goods and services): 5.5, 4.8, 5.4, 6.6, 6.6, 6.9, 6.6 ### Medium-term projections (Current Policies), FY2009–17 (selected) - Real GDP (percent change), FY2009–17: 1.0, 2.5, 2.1, 1.4, 0.8, 0.7, 0.6, 0.6, 0.6 - Consumer prices (percent change), FY2009–17: 7.8, 6.3, 4.6, 5.6, 4.2, 3.5, 2.7, 2.0, 2.0 - General government finance (percent of GDP), FY2009–17: - Revenue and grants: 65.9, 68.2, 65.9, 65.2, 62.6, 60.5, 59.3, 58.3, 57.5 - Grants: 44.5, 46.3, 44.1, 42.0, 40.6, 39.4, 38.5, 37.8, 37.2 - Expenditure: 64.2, 67.7, 65.3, 64.0, 61.8, 59.9, 58.6, 57.7, 56.9 - Overall balance: 1.6, 0.5, 0.6, 1.2, 0.8, 0.6, 0.6, 0.6, 0.6 - Compact Trust Fund (millions of US$; end of period), FY2009–17: 138.3, 177.2, 198.5, 257.4, 297.5, 341.0, 388.5, 440.0, 496.1 - Current account (in millions; percent of GDP) FY2009–17: - Current account (millions): -51.3, -48.7, -58.6, -49.0, -48.7, -49.0, -47.8, -46.9, -49.2 - Current account (percent of GDP): -18.5, -16.6, -18.9, -15.0, -14.3, -14.0, -13.3, -12.8, -13.2 - External debt (millions; end of period) FY2009–17: - Stock: 84.6, 84.3, 87.1, 87.1, 86.9, 86.8, 86.8, 86.3 - Stock (percent of GDP): 30.5, 28.7, 28.1, 26.6, 25.7, 24.9, 24.2, 23.7, 23.1 - Debt service: 3.9, 4.3, 5.0, 5.1, 5.0, 5.1, 5.0, 5.0, 5.1 - Debt service (percent of exports of goods and services): 6.6, 6.6, 6.9, 6.6, 6.1, 6.0, 5.6, 5.2, 5.2 ### Social indicators (selected) - Population (total, millions): 0.11 - Population growth rate (percent annual): 0.4 - GNI per capita (U.S. dollars): 2,900 - Health public expenditure (percent of GDP): 12.5 - Education public expenditure (percent of GDP): 6.7 - Gross primary enrollment (percent of school age population): 110 - Life expectancy at birth (years): Total 69; Male 68; Female 69 - Infant mortality (per thousand live births): 35 - Under 5 mortality (per thousand live births): 43 ### Risk Assessment Matrix — Sources of Risks, Likelihood, and Potential Impact - Strong intensification of the Euro area crisis - Likelihood: Medium - Potential impact: Medium - Analysis: Further slowdown in the Euro area would lower demand for exports from the FSM. Global slowdown would reduce fish exports (9 percent of GDP) and fishing license fees (6 percent of GDP). Tourism (8 percent of GDP) and household remittances (6 percent of GDP) would also be adversely affected. Mitigating factors: FSM's proximity to growing Asia and Pacific economies and limited direct exposure to the Euro area. - Global food price shock - Likelihood: Low - Potential impact: High - Analysis: High global food prices would create inflationary pressure in the FSM. The weight of food in the FSM CPI basket is 37 percent. - Global oil price shock - Likelihood: Low - Potential impact: Medium - Analysis: Continued turmoil in the Middle East could increase global fuel prices. Fuel weight in the CPI basket is 9 percent; higher fuel prices would hold back economic growth and worsen the current account balance. - Fiscal sustainability risks - Likelihood: High - Potential impact: High - Analysis: Declining reform momentum and political will would delay necessary fiscal reforms. Lack of progress in tax and expenditure reforms would undermine public confidence in fiscal sustainability, accelerate outward migration, and could disrupt provision of public services in the long run. - Financial sector risks - Likelihood: Low - Potential impact: Medium - Analysis: Economic slowdown could increase credit risks and NPLs at banks; many households are heavily indebted with short-term consumer loans. *Source: Country authorities and Fund staff calculations.* ### APPENDIX II. MICRONESIA—LONG-TERM FISCAL ### APPENDIX II. MICRONESIA—LONG-TERM FISCAL SUSTAINABILITY ### Overview - Purpose: Assess FSM’s long-term fiscal sustainability updating 2010 Article IV estimates and consider implications of the expected expiry of annual Compact grants in FY2023 and policy options to address the challenge. - Fiscal sustainability criterion: Government financial asset level at end-FY2023 that would generate investment income large enough to replace expiring Compact grants without significantly disrupting public services and eroding the value of the Compact Trust Fund (CTF). - All amounts in this appendix are in FY2011 prices, unless otherwise stated. - Assumed net investment return on CTF assets in all scenarios: 6 percent. ### Compact Trust Fund (CTF) performance and asset composition - CTF market value as of end-FY2012: $257 million. - CTF investment performance FY2008–12: - FY2008–09: net return on assets negative by a cumulative 17 percent. - FY2010–12: average annual rate of return about 7½ percent. - CTF asset allocation as of end-FY2012: - U.S. equity: 30 percent - non-U.S. equity: 30 percent - fixed income investment: 22 percent - real estate: 7 percent - hedge fund: 4 percent - private equity: 8 percent ### Baseline scenario — limited fiscal adjustment and structural reforms - Medium-term assumptions: - Medium-term fiscal surplus: around ½ percent of GDP (0.6 percent of GDP). - Medium-term real growth: about ½ percent. - Projected government financial assets by end-FY2023: about $840 million (in FY2011 dollars), comprising: - CTF: $770 million - other funds: about $70 million - During drawdown beginning FY2024: - Investment income: about $50 million per year. - Expiring Compact grants in FY2024: $66 million. - Resulting shortfall: about 5 percent of FY2011 GDP. - Note: shortfall would be about 10 percent of GDP if Supplemental Education Grants (SEG) is discontinued after FY2023. - Higher investment returns needed to fill gap without fiscal adjustment: - Net investment returns would need to remain at 7.2 percent per year until FY2023 to generate sufficient income. - Reliance on sustained high returns is not recommended given past volatility. ### Policy adjustment scenarios — achieving fiscal sustainability via accumulation and reforms - Common elements across adjustment scenarios: - Fortify recent fiscal surplus through comprehensive tax reform and cuts in wasteful current expenditures. - PFTAC preliminary estimate: planned tax reform could improve tax revenue by about 4 percent of GDP. - Structural reforms and accelerated utilization of infrastructure grants assumed to boost potential growth to about 2½ percent in the medium term. - Table of required fiscal adjustments (values in percent of GDP and USD millions, 2011 prices): - Baseline scenario: medium-term overall fiscal balance 0.6 (total required adjustment compared to FY2012: ---) - Swift adjustment scenario: - Medium-term overall fiscal balance: 6.4 percent of GDP - Total required adjustment compared to FY2012: 5.1 percent of GDP - Average annual fiscal adjustment: 1.3 percent of GDP - In USD millions (2011 prices): 4.0 - Swift adjustment scenario — if fiscal reforms are delayed by one year: - Medium-term overall fiscal balance: 7.0 percent of GDP - Total required adjustment compared to FY2012: 5.8 percent of GDP - Average annual fiscal adjustment: 1.4 percent of GDP - In USD millions (2011 prices): 4.5 - Gradual adjustment scenario: - Medium-term overall fiscal balance: 7.8 percent of GDP - Total required adjustment compared to FY2012: 6.6 percent of GDP - Average annual fiscal adjustment: 0.8 percent of GDP - In USD millions (2011 prices): 2.6 i) Swift adjustment scenario - Mechanics: - Gradually increase fiscal surpluses by about 1¼ percent of GDP per annum for four years to reach 6.4 percent of GDP in FY2016, and maintain that level until FY2023. - Outcome: - Consolidated government asset stock (including cumulative earnings) would reach about $1.1 billion by end-FY2023, generating sufficient income to offset expiring Compact grants. - Distributional note: - Given FSM’s federated system, fiscal surplus of each state belongs to itself; all states need to accumulate their own surpluses to contribute to closing the revenue gap. - Comparison: - Required adjustment higher by about ½ percent of GDP than in 2010 Article IV Staff Report due to shorter accumulation period until FY2023. ii) Gradual adjustment scenario - Mechanics: - Increase fiscal surpluses more gradually over eight years rather than four. - Fiscal surpluses increased by 0.8 percent of GDP per annum until reaching 7.8 percent of GDP in FY2020, then maintained until FY2023. - Outcome: - Expected CTF assets in FY2023 same as under swift adjustment scenario, but requires higher overall level of fiscal surplus because of slower accumulation. ### Risk analysis and sensitivity - Delay in reform implementation: - If swift scenario reforms delayed by one year, required medium-term fiscal surplus to achieve sustainability would be 7.0 percent of GDP (higher by 0.6 percentage points). - Growth sensitivity: - If growth is 1½ percent rather than 2½ percent, the required fiscal surplus in FY2016 under the swift scenario would be 6.7 percent of GDP (higher by 0.3 percentage points). - Investment return sensitivity: - If net investment return assumed 5 percent rather than 6 percent, the required fiscal surplus in FY2016 under the swift scenario would be 12.0 percent of GDP, about twice the adjustment under the initial assumption. - Policy implication: Sensitivity analyses highlight importance of swift reform implementation and building policy buffers. ### Key policy recommendations and structural priorities - Comprehensive revenue reform: - Implement planned tax reform package (including introduction of a VAT and a net profits tax, and establishment of the Unified Revenue Authority (URA)) expected to raise revenue by about 4 percent of GDP. - Proceed with public financial management reform in tandem to protect benefits of fiscal reforms. - Expenditure restraint: - Cut wasteful current expenditures and consider cuts in wages and salaries as part of broader consolidation measures (as modeled in adjustment scenarios). - Public enterprise reform: - Address fiscal burden from public enterprises (e.g., higher wages, subsidized loans, exemption from gross revenue tax); continue steps such as shutdown of insolvent enterprises. - Financial sector reform: - Improve access to credit by redirecting FSM Development Bank toward supporting start-ups, expand micro-credit through credit unions and micro-credit agencies with appropriate supervision, and improve secured transaction framework. - Statistical capacity strengthening: - Strengthen statistical system to produce timely and reliable data on tourism, fisheries, agriculture, and other sectors to inform policy responses. *Source: APPENDIX II. MICRONESIA—LONG-TERM FISCAL SUSTAINABILITY (staff estimates and analysis, in FY2011 prices).* ### ANNEX III. RELATIONS WITH THE ASIAN ### ANNEX III. RELATIONS WITH THE ASIAN DEVELOPMENT BANK (ASDB) ### Membership and historical assistance - The Federated States of Micronesia became a member of the AsDB in 1990. - As at December 2011, the FSM has received: - Eight loans - 1 grant - 43 TA grants ### ADB objectives and operational approach - ADB assistance objectives: - Supporting infrastructure development - Supporting public sector management, with a particular focus on economic management and accountability - Ensuring inclusive social development - Promoting sustained private sector-led economic growth - ADB approach to operations: - Focus on a few key constraints - Careful analysis of the political economy - Preparedness to closely manage and support operations - Move away from complex federally administered and state delivered multistate and multi-sector projects - Adoption of home grown solutions - Simple and realistic project outcomes ### Country operations business plan (2013–2015) — planned focus and pipeline - Support will be formulated in the context of the “Action Plan 2023” and the “Development Framework” presented at the recent FSM Development Partners Forum. - Planned attention: - Infrastructure development, especially power sector development and transport - Long-term, well-coordinated approach to strengthening public financial management, including technical assistance to develop capacity for sector investment planning in infrastructure - Capacity development support to the education sector, coordinated with Compact financial support - Discussion of a “binding constraints assessment” in the tourism sector - Key pipeline initiatives: - Yap Renewable Energy Project - Pohnpei Energy Sector project - Pohnpei Port Development project ### Active loans and specific projects - Currently there are two active loans. - The Omnibus Infrastructure Development project loans (totaling $19m), approved in 2004, are designed to: - Enhance public health, environmental quality, and surface water quality through improved wastewater infrastructure and management for Pohnpei - Improve delivery of water services and expand water supply systems for Yap and Kosrae - Improve management and provision of power in Chuuk ### Non-lending program and capacity building - ADB’s non-lending program has focused on: - Improving public sector efficiency, effectiveness, and accountability - Raising public awareness through community consultation and participation programs, particularly in Chuuk and Kosrae - Further Technical assistance will be provided to: - Provide capacity building in project management and procurement processes to support infrastructure development ### Loans by sector (Table 1 — amounts and counts as of December2011) - Agriculture and Natural Resources: No. 1.0; Amount 6.5 - Energy: No. 0.0; Amount 0.0 - Industry and Nonfuel Minerals: No. 0.0; Amount 0.0 - Transportation: No. 0.0; Amount 0.0 - Communications: No. 0.0; Amount 0.0 - Law, Economic Management and Public Policy: No. 3.0; Amount 31.0 - Water Supply, Sanitation & Waste Management: No. 1.0; Amount 10.6 - Multisector: No. 3.0; Amount 27.0 - Other: No. 0.0; Amount 0.0 - Total: No. 8.0; Amount 75.1 - Memorandum Item: Technical Assistance Provided 43; 25.7 ### Loan approvals, disbursements, and undisbursed balances (Table 2 — in millions of U.S. dollars) - Loan Approvals by year: - 2002: 0.0 - 2003: 0.0 - 2004: 19.0 - 2005: 0.0 - 2006: 0.0 - 2007: 0.0 - 2008: 0.0 - 2009: 0.0 - 2010: 0.0 - 2011: 0.0 - 1990-2011 Total: 75.1 - Loan Disbursements by year: - 2002: 1.4 - 2003: 2.7 - 2004: 1.1 - 2005: 1.7 - 2006: 2.5 - 2007: 3.6 - 2008: 3.6 - 2009: 0.8 - 2010: 1.1 - 2011: 6.3 - 1990-2011 Total: 49.5 - Undisbursed balance at the end of the year (by year): - 2002: 22.0 - 2003: 19.2 - 2004: 18.1 - 2005: 16.4 - 2006: 13.9 - 2007: 10.3 - 2008: 6.8 - 2009: 6.0 - 2010: 17.7 - 2011: 11.5 - Memorandum Item: TA Approvals by year (partial series shown): - 2002: 1.0 - 2003: 1.2 - 2004: 0.85 - 2005: 0.0 - 2006: 0.6 - 2007: 0.4 - 2008: 0.8 - 2009: 0.0 - 2010: 0.0 - 2011: 0.7 - 1990-2011 Total: 25.7 *Source: ANNEX III. RELATIONS WITH THE ASIAN DEVELOPMENT BANK (ASDB), as provided in the content unit.* ### ANNEX V. STATISTICAL ISSUES ### ANNEX V. STATISTICAL ISSUES ### Assessment of data adequacy for surveillance - General: Data have serious shortcomings that significantly hamper surveillance. Shortcomings are most serious in government finance and balance of payments statistics. - National Accounts: - External consultants funded by the U.S. Department of Interior prepared the national income accounts from FY1995 to FY2011. - Some shortcomings remain, for instance, no unemployment and investment/savings indicators are available. - Price statistics: - A quarterly consumer price index (CPI) — rebased to Q2 2008 and utilizing expenditure weights derived from an earlier household survey — is published for the Federated State of Micronesia (FSM) as a whole and for each state. - Data releases suffer from considerable lags, preventing accurate and timely evaluation of domestic price movements. Example: the FY2012 consumer price index has not yet been finalized. - Government finance statistics: - National and state governments and public sector enterprises publish annual audit reports detailing fiscal operations; consultants put these data in a GFS format with a lag of about one year. - Accuracy of tax revenue data needs improvement as they are sometimes different from audit reports. - Further improvements in quality and timeliness depend on greater cooperation between national and state governments. - Micronesia does not present fiscal data using the Government Finance Statistics Manual 2001 (GFSM 2001) format. - Monetary statistics: - The Banking Commissioner reports monthly monetary data to STA with a two- to three-month lag. - Data comprise interest rates, the accounts of the monetary authorities, commercial banks, and the FSM Development Bank. - The Commissioner considers banking law prevents sharing of this information outside the Banking Board, hampering domestic surveillance. - Balance of payments: - The Office of Statistics, Budget & Economic Management, Overseas Development Assistance and Compact Management (SBOC) publishes annual estimates of the balance of payments and external debt statistics. - Data on workers’ remittances are highly incomplete. - Delays of data release impart a high degree of uncertainty to analysis of external sector developments. - The SBOC aims to produce quarterly balance of payments statistics and to introduce new data sources, such as surveys. - Micronesia participates in the JSA Project on the Improvement of External Sector Statistics in the APD region. ### Data standards and quality - Micronesia does not participate in the IMF’s General Data Dissemination System. - No data ROSC is available. ### Reporting to STA (optional) - Only international liquidity and monetary statistics are currently reported to STA for publication in the International Financial Statistics (IFS). - Micronesia does not submit balance of payments data to STA for publication in the IFS or the Balance of Payments Statistics Yearbook (BOPSY). ### Table of Common Indicators Required for Surveillance (selected data and metadata as of December 10, 2012) - Exchange Rates: Date of latest observation Nov. 2012; Date received Nov. 2012; Frequency of Data D; Frequency of Reporting D; Frequency of publication D. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication M. - Reserve/Base Money: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication NA. - Broad Money: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication NA. - Central Bank Balance Sheet: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication NA. - Consolidated Balance Sheet of the Banking System: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication NA. - Interest Rates: Date of latest observation Aug. 2012; Date received Nov. 2012; Frequency M; Reporting M; Publication M. - Consumer Price Index: Date of latest observation 2011Q4; Date received Aug. 2012; Frequency Q; Reporting A; Publication I. - Revenue, Expenditure, Balance/Composition of Financing (General Government and Central Government): Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication A. - Stocks of Central Government and Central Government-Guaranteed Debt: N/A across observations, reporting, and publication. - External Current Account Balance: Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication I. - Exports and Imports of Goods and Services: Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication I. - GDP/GNP: Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication I. - Gross External Debt: Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication I. - International Investment Position: Date of latest observation FY2011; Date received Aug. 2012; Frequency A; Reporting A; Publication A. - Frequency codes: Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA). ### Key statistical findings and selected indicators (from the PIN and Selected Economic Indicators) - Macroeconomic context and data highlights: - FSM economy grew by 2–2½ percent for FY2010 and FY2011. - Inflation: 4.6 percent in FY2011 after a peak of 7.8 percent in FY2009. - Growth in FY2012 is estimated at 1.4 percent. - A modest consolidated fiscal surplus of 1¼ percent of GDP is expected in FY2012, mainly due to a sharp increase in fishing access fee revenue by $7.6 million. - Medium-term growth is estimated to stay low at about ½ percent. - Selected table figures (FY2008–13, as presented): - Real GDP: FY2008 -2.6; FY2009 1.0; FY2010 2.5; FY2011 2.1; FY2012 Est. 1.4; FY2013 Proj. 0.8. - Consumer prices: FY2008 6.6; FY2009 7.8; FY2010 6.3; FY2011 4.6; FY2012 Est. 5.6; FY2013 Proj. 4.2. - Employment: FY2008 -4.8; FY2009 -0.3; FY2010 4.1; FY2011 2.3; FY2012 Est. 0.2; FY2013 Proj. 0.1. - Consolidated government finance (in percent of GDP): - Revenue and grants: FY2008 57.3; FY2009 65.9; FY2010 68.2; FY2011 65.9; FY2012 Est. 65.2; FY2013 Proj. 62.6. - Revenue: FY2008 21.2; FY2009 21.4; FY2010 21.8; FY2011 21.8; FY2012 Est. 23.3; FY2013 Proj. 22.0. - Grants: FY2008 36.1; FY2009 44.5; FY2010 46.3; FY2011 44.1; FY2012 Est. 42.0; FY2013 Proj. 40.6. - Expenditure: FY2008 59.0; FY2009 64.2; FY2010 67.7; FY2011 65.3; FY2012 Est. 64.0; FY2013 Proj. 61.8. - Overall balance: FY2008 -1.7; FY2009 1.6; FY2010 0.5; FY2011 0.6; FY2012 Est. 1.2; FY2013 Proj. 0.8. - Compact Trust Fund (millions of U.S. dollars): FY2008 119.1; FY2009 138.3; FY2010 177.2; FY2011 198.5; FY2012 Est. 257.4; FY2013 Proj. 297.5. - Commercial banks (millions of U.S. dollars; end of period): - Foreign assets: FY2008 101.4; FY2009 121.5; FY2010 127.7; FY2011 143.6; FY2012 Est. 156.2; FY2013 Proj. 169.8. - Loans: FY2008 49.2; FY2009 46.7; FY2010 55.7; FY2011 55.2; FY2012 Est. 60.0; FY2013 Proj. 65.3. - Total deposits: FY2008 118.9; FY2009 132.5; FY2010 154.1; FY2011 166.2; FY2012 Est. 175.2; FY2013 Proj. 181.8. - Interest rates (percent, average for FY): - Consumer loans: FY2008 14.4; FY2009 15.4; FY2010 15.1; FY2011 14.4; FY2012 Est. 15.0; FY2013 Proj. 14.8. - Commercial loans: FY2008 8.5; FY2009 7.4; FY2010 6.6; FY2011 6.6; FY2012 Est. 8.1; FY2013 Proj. 7.7. - Balance of payments (millions of U.S. dollars): - Trade balance: FY2008 -121.7; FY2009 -128.4; FY2010 -130.7; FY2011 -134.2; FY2012 Est. -133.1; FY2013 Proj. -130.4. - Net services and income: FY2008 -27.6; FY2009 -31.3; FY2010 -30.1; FY2011 -32.4; FY2012 Est. -24.5; FY2013 Proj. -25.6. - Private and official transfers: FY2008 105.5; FY2009 108.4; FY2010 112.1; FY2011 108.0; FY2012 Est. 108.7; FY2013 Proj. 107.3. - Current account including official transfers: FY2008 -43.8; FY2009 -51.3; FY2010 -48.7; FY2011 -58.6; FY2012 Est. -49.0; FY2013 Proj. -48.7. - (in percent of GDP) FY2008 -16.7; FY2009 -18.5; FY2010 -16.6; FY2011 -18.9; FY2012 Est. -15.0; FY2013 Proj. -14.3. - Current account excluding official transfers: FY2008 -142.6; FY2009 -155.9; FY2010 -157.2; FY2011 -162.2; FY2012 Est. -153.9; FY2013 Proj. -152.0. - (in percent of GDP) FY2008 -54.6; FY2009 -56.2; FY2010 -53.4; FY2011 -52.3; FY2012 Est. -47.0; FY2013 Proj. -44.8. - Overall balance: FY2008 -3.0; FY2009 -1.6; FY2010 -0.3; FY2011 0.9; FY2012 Est. 6.5; FY2013 Proj. 0.9. - (in percent of GDP) FY2008 -1.2; FY2009 -0.6; FY2010 -0.1; FY2011 0.3; FY2012 Est. 2.0; FY2013 Proj. 0.3. - Gross reserves (in months of imports): FY2008 2.5; FY2009 2.7; FY2010 2.8; FY2011 3.6; FY2012 Est. 3.6; FY2013 Proj. 3.6. - External debt (millions of U.S. dollars; end of period): - Stock: FY2008 74.1; FY2009 84.6; FY2010 84.3; FY2011 87.1; FY2012 Est. 87.1; FY2013 Proj. 87.1. - (in percent of GDP) FY2008 28.4; FY2009 30.5; FY2010 28.7; FY2011 28.1; FY2012 Est. 26.6; FY2013 Proj. 25.7. - Debt service: FY2008 3.2; FY2009 3.9; FY2010 4.3; FY2011 5.0; FY2012 Est. 5.1; FY2013 Proj. 5.0. - (in percent of exports of goods and services) FY2008 5.4; FY2009 6.6; FY2010 6.6; FY2011 6.9; FY2012 Est. 6.6; FY2013 Proj. 6.1. - Real effective exchange rate (Year 2000=100): FY2008 97.5; FY2009 106.7; FY2010 108.6; FY2011 107.6; FY2012 Est. 108.1; FY2013 Proj. 108.5. ### Statistical policy implications and priorities (as identified in the material) - Improve quality and timeliness of fiscal data through greater cooperation between national and state governments and move toward GFSM 2001 presentation. - Increase timeliness and coverage of price data (CPI) to allow accurate and timely evaluation of domestic price movements. - Address undercoverage in workers’ remittances and reduce delays in balance of payments data; SBOC plans quarterly BOP and new data sources (surveys). - Enhance sharing of monetary data reported by the Banking Commissioner to support domestic surveillance. - Step up production of high quality economic statistics, especially in the fiscal area, to strengthen monitoring and policy analysis. *Source: ANNEX V. STATISTICAL ISSUES, as of December 10, 2012, from the IMF staff report materials provided in the content unit.* ### 2023. The reduction in the Compact assistance presents the biggest challenge for the future outlook. ### _cr1316 - 2023. The reduction in the Compact assistance presents the biggest challenge for the future outlook. ### Summary and key challenges - FSM is highly dependent on public sector demand and Compact grant assistance; reduction in Compact assistance is the biggest challenge for the future outlook. - Achieving long-term budget self reliance is urgent given the difficulty of the private sector to offset declines in public sector demand. - Authorities broadly agree with staff recommendations and reaffirm commitment to work with the Fund and development partners to facilitate economic growth and reduce dependency on external aid support beyond 2023. ### Economic developments and outlook - 2012 growth is forecast to drop to 1.4 per cent from 2.1 per cent in FY2011. - Fisheries and agriculture show a pick up, but near-term outlook is cloudy due to declining public sector demand from Compact grant reduction. - Inflationary pressure has been alleviated but would remain volatile and subject to fluctuations in international commodities prices. - Consolidated government balance continued to record modest surplus at around 1 per cent of GDP. - Results uneven across states: two states recorded deficits equivalent to 1 per cent of state GDP. - Public debt remains relatively low at below 30 per cent of GDP. - Compact Trust Fund (CTF) assets amount to 83 per cent of GDP. - CTF assets are insufficient to support budget self reliance beyond 2023 and aggravating social security balances will increase long-term budgetary pressure. - FSM has 607 islands, occupying a land mass of around 700 km2. - FSM gained its independence in 1986 under a Compact of Free Association with the United States. ### Medium-term challenge and fiscal policy response - Long-term pressures: reduction in Compact grants disbursement, decreasing population due to continued outward migration, and weak private sector growth. - Authorities agree on need for significant fiscal adjustments over the medium term; pace to be determined based on detailed assessments. - The authorities set up the 2023 Planning Committee under the leadership of President Mori to develop a realistic action plan to address budgetary shortfalls beyond 2023; authorities agree on need to strengthen the Committee by approving its budget. - Headway made in garnering support from state governments, business sector, and general public; first stakeholders conference held in fall of 2012 produced favorable outcomes and development partner support. - Tax reform initiatives continued in 2012: - A Unified Revenue Authority (URA) has been set up. - Net profit tax to come into effect in October 2013. - Value added tax to become effective in October 2014. - URA will take over from the national and state revenues authorities. - Two out of the four states have agreed to the new tax regime; new arrangement comes into force once all four states sign and agree. - Authorities will continue staff training and IT system upgrades to strengthen tax administration. - Expenditure-side measures: - Improve operational efficiency of current and capital expenditure through better planning and coordination between national and state governments. - Public wage rates considered high compared to some regional peers; reducing rates would allow fiscal savings, but compensation must balance outmigration of skilled workforce. - Efforts to improve social security balance include amendment to Social Security Act regarding adjusting the retirement age to Age 60 and allowing only 50 per cent of benefits until Age 65. - Commitment to strengthen public financial management with continued work with Pacific Financial Technical Assistance Center (PFTAC). ### Financial sector - Commercial banks are the main financial players; they are well capitalized with sufficient liquidity. - Non-performing loan levels are low, but domestic lending opportunities remain limited with foreign banks placing most funds and investments offshore. - Authorities will focus on addressing constraints related to collaterals in lending; enactment of the Secured Transaction Act in 2006 was a step forward. - Authorities will continue to address land collateral issues to support long-term loan financing. - Development Bank of FSM provides financing for government-priority sectors and sectors outside commercial banks’ lending policies; authorities recognize need to strengthen supervisory oversight over the Development Bank’s operations. ### Private sector growth and development prospects - Private sector development is weak and needs strengthening to support growth as US Compact grant winds down. - FSM has competitive advantages in some niche tourism markets; authorities agree on need to promote and attract inward FDIs. - Signs of FDI interest in tourism, including a large project proposal that raises land tenure protection challenges. - Alternative strategy: attract small-scale FDIs to generate immediate benefits while building capacity for larger FDIs. - Agriculture has potential to increase locally grown food production to mitigate volatility of imported food prices. - Fisheries sector has room to grow and provide greater domestic employment. - Government will continue reforms to ease cost of doing business and devise a nation-wide development plan, building on momentum from the first development Partners Forum held in the fall of 2012. - An Investors’ and Bankers’ symposium is planned for mid-Spring to harness support from domestic and international lenders for priority development projects. ### Conclusion and policy priority - Future prospects are challenging due to unfavorable global market conditions and the winding down of US Compact support on which the economy is heavily dependent. - FSM authorities have made positive strides on reforms; key priorities: - Fortify support from state governments and the general public. - Strengthen public finance and savings toward the 2023 deadline. - Foster private sector development to support sustainable economic growth. - Authorities will continue to work closely with the Fund and development partners to implement reform agenda. *Source: _cr1316 - 2023. The reduction in the Compact assistance presents the biggest challenge for the future outlook.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr1316.pdf_