## 1. Climate Change Challenges and Adaptation Policies ## Source details **Canonical URL:** [1. Climate Change Challenges and Adaptation Policies](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16135.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16135.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16135.pdf.json) --- ### Setting and exposure - Maldives living standards rose to middle income levels over the past two decades driven by tourism; tourism directly or indirectly accounts for three quarters of activity with income per capita reaching $6792 in 2014. - Geography and service delivery: - 1,192 islands, 188 inhabited, spread over 90,000 sq kms, creating high costs for provision of public services across far-flung islands. - Climate exposure: - 80 percent of the total land area is less than 1 meter above the mean sea level. - Half of all settlements, including tourist resorts, and two thirds of key infrastructure are within 100 meters of the coastline. - High urban density in Malé (home to a third of the population) adds to vulnerability. - Drought and flooding are already occurring with greater frequency. ### Climate change economic impact scenarios and international context - Business-as-usual (no global action) projected costs for Maldives: - 2 percent of annual GDP in 2050. - 12 percent of annual GDP in 2100. - Copenhagen-Cancun scenario (keeping mean temperature rise below 2 C): - Losses could be limited to around 3.5 percent of annual GDP by 2100. - Paris COP 21: - Successful implementation is critical for Maldives; it will help mobilize grants and concessional financing in key adaptation areas. - Policy insight: - Early investment in adaptation can help limit losses in later decades; climate change policies are most effective when integrated in a sustainable development strategy. ### Adaptation challenges and priority areas (public and private costs) - Renewable energy: - Reliant on fossil fuels for electricity generation and faces the highest costs in South Asia. - Solar energy is being developed, but geography and population dispersion pose challenges. - Voluntary population resettlement: - Consolidating onto fewer islands over the longer term is necessary to adapt and would reduce service provision costs. - Infrastructure resilience: - Coastal protection of inhabited islands, resorts, airports and ports is a priority. - Water security: - Rainwater is the main drinking source for many islands; changes in annual rainfall patterns create drought and localized water stress, requiring desalination and strengthened water resource management, including by the tourism industry. - Biodiversity and waste management: - Protect coral reefs and reduce pollution; improve waste management. - Health: - Higher risks from vector and water borne diseases identified as an emerging challenge. - Tourism and fisheries: - Protect coral reefs, beaches and coastal infrastructure for tourism. - Fisheries need to adapt to changes in sea temperature. ### Recent macroeconomic context linked to climate and infrastructure needs - Growth and tourism: - Growth slowed from 6.5 percent in 2014 to around 2 percent in 2015. - Total tourist arrivals: 1.23 million in 2015 (compared with 0.79 million in 2010). - External and monetary indicators: - Current account deficit widened to 8 percent of GDP in 2015. - Gross official reserves fell to $564mn at the end of 2015. - Parallel market exchange rate premium increased to 6 percent in January 2016 from 3–4 percent in 2015. - Inflation: 1.2 percent y on y in December (year not specified in excerpt). - Fiscal position: - 2014 fiscal deficit estimated by staff to have reached 9.1 percent (previously expected at 11.6 percent of GDP). - Public debt: 73.1 percent of GDP in 2015 (above the 60 percent limit in the Fiscal Responsibility Law). - Outstanding domestic arrears have been reduced. - Financial sector: - Private sector credit rose 13 percent in the year to December (year not specified in excerpt). - Banks met capital adequacy ratios; NPLs are down from the 2011 peak. ### Public infrastructure scale up: scope, costs, and risks - Staff estimate: three main projects cost around 35 percent of GDP and would double capital spending in the next three years (Debt Sustainability Analysis). - Three large projects planned (costs and features): - International airport development: - Cost totaling around US$828mn. - New runway and terminal would increase passenger capacity fivefold (to 7.5 mn). - Risks: engineering complexity, implementation capacity, availability of financing. - Phase II Hulhumalé development and bridge: - Cost totaling around $400mn. - Develops a new population center next to the international airport and Malé to support population resettlement, ease overcrowding, and expand electricity generation at lower cost. - Port relocation and development: - Would improve resilience to climate change, ease bottlenecks and reduce transport costs; at an early stage of planning with financing yet to be identified. - Potential upsides: - Airport development could remove a key growth inhibitor and attract additional foreign investment. - Average accommodation occupancy at 70 percent indicates short-term capacity to boost tourism. - Shift toward emerging Asia has expanded markets. - Some capital projects may aid climate adaptation by diversifying activity and easing congestion in Malé. - Downside risks: - Bulk of infrastructure capital and labor will be imported, increasing foreign exchange needs and external loan financing. - If growth benefits do not materialize, debt may become unsustainable as infrastructure loans amortize. - Strengthened management of the capital budget is needed to realize growth benefits. ### Policy implications and recommendations - Domestic adaptation measures: - Encourage voluntary resettlement onto fewer islands over the longer term. - Promote renewable energy (acknowledging geographic and dispersion challenges). - Improve waste management and environmentally-friendly tourism infrastructure. - Strengthen water resource management policies, including within the tourism industry. - Protect biodiversity and coral reefs; improve coastal protection for inhabited islands, resorts, airports and ports. - Enhance public investment management and capital budget oversight to ensure infrastructure yields growth benefits and limits fiscal and external risks. - External engagement: - Successful global mitigation efforts and implementation of international agreements will reduce economic burden and help mobilize grants and concessional financing for adaptation. ### Outlook and risks summary - Near term: - Growth expected to pick up to 3.5 percent in 2016 supported by modest tourism recovery and infrastructure activity. - Medium term: - Staff assume a ½ percent of GDP per year increase in medium-term potential growth from tourism development; growth peaks at 5 percent (below previous 6.5 percent). - Major downside risks: - Sharper than expected slowdown in China and persistent U.S. dollar appreciation could dent tourism. - Policy mistakes (e.g., external debt-financed capital expenditure that raises already elevated debt; tax incentives that erode the tax base). - Re-emergence of political tensions would exacerbate vulnerabilities. *Source: IMF country report excerpt — "1. Climate Change Challenges and Adaptation Policies."* ### 1. Climate Change Challenges and Adaptation Policies ____________________________________________5 ### 1. Climate Change Challenges and Adaptation Policies ### Setting and exposure - Maldives living standards rose to middle income levels over the past two decades driven by tourism; tourism directly or indirectly accounts for three quarters of activity with income per capita reaching $6792 in 2014. - Unique geography: 1192 islands, 188 inhabited, spread over 90000 sq kms, creating high costs for provision of public services across far-flung islands. - High exposure to climate change: - 80 percent of the total land area is less than 1 meter above the mean sea level. - Half of all settlements, including tourist resorts, and two thirds of key infrastructure are within 100 meters of the coastline. - High urban density in the capital Malé (home to a third of the population) adds to vulnerability. - Drought and flooding are already occurring with greater frequency. ### Climate change economic impact scenarios and international context - Without global action (business as usual), projected economic costs for Maldives: - 2 percent of annual GDP in 2050. - 12 percent of annual GDP in 2100. - With global action (Copenhagen-Cancun scenario—keeping the mean temperature rise below 2 C), losses could be limited to around 3.5 percent of annual GDP by 2100. - Successful implementation of the Paris COP 21 agreement is critical for Maldives; it will help mobilize grants and concessional financing in key adaptation areas. - Evidence indicates early investment in adaptation can help limit losses in later decades; climate change policies are most effective when integrated in a sustainable development strategy. ### Adaptation challenges and priority areas (public and private costs) - Developing renewable energy: - Maldives is reliant on fossil fuels for electricity generation and faces the highest costs in South Asia. - Solar energy is being developed, but geography and population dispersion pose challenges. - Promoting voluntary population resettlement: - Consolidating onto fewer islands over the longer term is necessary to adapt and would reduce service provision costs. - Improving infrastructure resilience: - Coastal protection of inhabited islands, resorts, airports and ports. - Water security: - Rainwater is the main drinking source for many islands; changes in annual rainfall patterns create drought and localized water stress, requiring desalination and strengthened water resource management, including by the tourism industry. - Protection of biodiversity and better waste management: - Critical to conserve coral reefs and reduce pollution. - Health: - Higher risks from vector and water borne diseases identified as an emerging challenge. - Tourism and fisheries industries: - Protection of coral reefs, beaches and coastal infrastructure is essential for tourism. - Fisheries will need to adapt to changes in sea temperature. ### Recent macroeconomic context linked to climate and infrastructure needs - Growth and tourism: - Growth slowed from 6.5 percent in 2014 to around 2 percent in 2015. - Total tourist arrivals: 1.23 million in 2015 (compared with 0.79 million in 2010). - External and monetary indicators: - Current account deficit widened to 8 percent of GDP in 2015. - Gross official reserves fell to $564mn at the end of 2015. - Parallel market exchange rate premium increased to 6 percent in January 2016 from 3–4 percent in 2015. - Inflation: 1.2 percent y on y in December (year not specified in excerpt). - Fiscal position: - 2014 fiscal deficit estimated by staff to have reached 9.1 percent (previously expected at 11.6 percent of GDP). - Public debt on a rising trajectory: 73.1 percent of GDP in 2015 (above the 60 percent limit in the Fiscal Responsibility Law). - Outstanding domestic arrears have been reduced. - Financial sector: - Private sector credit rose 13 percent in the year to December (year not specified in excerpt). - Banks met capital adequacy ratios; NPLs are down from the 2011 peak. ### Public infrastructure scale up: scope, costs, and risks - Staff estimate the three main projects cost around 35 percent of GDP and would double capital spending in the next three years (Debt Sustainability Analysis). - Three large projects planned (Box 2): - International airport development: - Cost totaling around US$828mn. - New runway and terminal would increase passenger capacity fivefold (to 7.5 mn). - Risks: engineering complexity, implementation capacity, availability of financing. - Phase II Hulhumalé development and bridge: - Cost totaling around $400mn. - Develops a new population center next to the international airport and Malé to support population resettlement, ease overcrowding, and expand electricity generation at lower cost. - Port relocation and development: - Would improve resilience to climate change, ease bottlenecks and reduce transport costs; at an early stage of planning with financing yet to be identified. - Positive potential from scale up: - Airport development could remove a key growth inhibitor and attract additional foreign investment. - Room to grow tourism: average accommodation occupancy at 70 percent indicates short-term capacity to boost tourism. - Maldives has successfully attracted new markets (shift toward emerging Asia). - Some capital projects may aid climate change adaptation by diversifying activity and easing congestion in Malé. - Downside risks: - Bulk of infrastructure capital and labor will be imported, increasing foreign exchange needs and external loan financing. - If growth benefits do not materialize, debt may become unsustainable as infrastructure loans amortize. - Strengthened management of the capital budget is needed to realize growth benefits. ### Policy implications and recommendations (from source) - Domestic adaptation policy measures highlighted: - Encourage voluntary resettlement onto fewer islands over the longer term. - Promote renewable energy (noting geographic and dispersion challenges). - Improve waste management and environmentally-friendly tourism infrastructure. - Strengthen water resource management policies, including within the tourism industry. - Protect biodiversity and coral reefs; improve coastal protection for inhabited islands, resorts, airports and ports. - Enhance public investment management and capital budget oversight to ensure infrastructure yields growth benefits and limits fiscal and external risks. - External engagement: - Successful global mitigation efforts and implementation of international agreements will reduce economic burden and help mobilize grants and concessional financing for adaptation. ### Outlook and risks summary - Near term: Growth is expected to pick up to 3.5 percent in 2016 supported by modest tourism recovery and infrastructure activity. - Medium term: Staff assume a ½ percent of GDP per year increase in medium-term potential growth from tourism development (consistent with average public investment efficiency of less developed economies); growth peaks at 5 percent (below previous 6.5 percent). - Major downside risks: - Sharper than expected slowdown in China and persistent U.S. dollar appreciation could dent tourism. - Policy mistakes (e.g., external debt-financed capital expenditure that raises already elevated debt; tax incentives that erode the tax base). - Re-emergence of political tensions would exacerbate vulnerabilities. *Source: IMF country report excerpt — "1. Climate Change Challenges and Adaptation Policies."* ### 19. There is little policy space to respond to risks. Reserves are low and there is no fiscal ### _cr16135 - 19. There is little policy space to respond to risks. Reserves are low and there is no fiscal ### Policy space and risks - There is little policy space to respond to risks: reserves are low and there is no fiscal space to absorb shocks (including climate change related shocks). - Fiscal slippage would likely be accompanied by capital outflows, pressure on the parallel foreign exchange market premium, and an erosion of official reserves. - In such circumstances an accelerated fiscal adjustment would be needed with measures to shore up revenues as well as sustained and durable expenditure restraint. - Upside and downside risk matrix (likelihood / impact as reported): - Upside - 1. Tourism demand recovers more strongly than expected. Medium / Medium - 2. Decisive and durable fiscal consolidation effort puts policy back on track. Low / High - Downside - 1. Political tensions escalate and dent tourism. Medium / Medium - 2. Structurally weak growth in China – medium term; a sharp slowdown in growth in China in 2015/16 – short term; Persistent dollar strength (short term). Medium / Low / High / High/ Medium - 3. Policy slippage exacerbates the downside. High/ Medium / High ### Authorities’ expectations - Authorities expect growth to bounce back to over 6 percent in 2016 and to remain stronger than staff projections over the medium term. - They expect sizeable domestic spillovers from public investment, in construction and tourism. - On fiscal policy, authorities expect non-tax revenues to rise sharply (including from SEZs and new resort leases) to help cover capital spending and plan to adjust spending if revenues are not forthcoming. ### Fiscal stance, recent developments, and staff concerns - Staff view: The 2016 Budget is expansionary; public spending on wages, subsidies and social welfare has risen sharply in recent years. - 2015 progress: deficit narrowing through revenue measures, a public employment freeze and streamlining of electricity subsidies. - Staff is not confident that the authorities’ 2016 deficit targets can be met: - Revenues: Authorities project a substantial boost to non-tax revenues from SEZs and new resort leases; staff view such a large increase as unattainable in the near term. - Expenditures: Staff projects less capital and more current spending than authorities; both parties agree firm control over the public sector wage bill is needed. Reversal of the decision to fully eliminate electricity subsidies will add to costs. ### Debt trajectory and risk - Without fiscal adjustment, staff projects public debt could reach 121 percent of GDP in 2020 and continue rising, substantially above limits in the Fiscal Responsibility Law (FRL). - The risk of external debt distress has deteriorated to a high risk rating. - Recent debt contracts: semi-concessional terms despite PRGT eligibility. ### Staff’s fiscal policy recommendations (high level) - Durable fiscal adjustment is needed to prevent growing fiscal and external imbalances; requires both expenditure restraint and further revenue measures. - Use interim targets for the current primary balance to anchor adjustment while FRL limits are unlikely to be achieved near term. - More strictly prioritized overall capital spending and a medium term debt strategy guided by the FRL would help anchor the debt path. - Support priority public infrastructure spending where feasibility studies demonstrate viability. - Recognize low fiscal multipliers in Maldives; growth impact of consolidation should be contained. ### Quantified adjustment potential and specific measures - Feasible measures could improve the current primary balance by 5.5 percentage points of GDP by 2020. - Revenue measures recommended: - Charge user fees for key infrastructure (e.g., bridge toll, increase in airport departure tax). - Broaden the base of the business profits tax (BPT) and increase rates on other taxes; tourism goods and services tax and BPT have room relative to comparators. - Raise resort rent and loyalties; and/or excises. - Expenditure measures recommended: - Contain the wage bill; restart public service review. - Better target social welfare and food subsidies through means testing; eliminate electricity subsidy (the latter was postponed). - Baseline costs review of healthcare to identify savings. - Strengthen SOE transparency and oversight. - Increase use of renewable energy to reduce costs. - COP21 opportunity: Presenting climate-change adaptation features and quantifying costs in each Budget could mobilize resources for small states. ### Fiscal projections and illustrative scenarios (selected reported figures, in percent of GDP) - Preliminary Fiscal Projections 2015–2017 (Authorities and Staff, in percent of GDP) - Total Revenue (excl grants): 34.5, 35.1, 42.6, 35.1, 39.5, 34.0 - Tax Revenue: 25.0, 25.3, 27.3, 26.7, 27.6, 26.2 - Non-tax revenue: 9.5, 9.7, 15.4, 8.2, 11.9, 7.7 - Total Expenditure & net lending 1/: 44.2, 44.3, 51.7, 48.9, 49.7, 52.5 - Current Expenditure: 33.7, 35.4, 32.1, 35.9, 30.1, 36.2 - Capital Expenditure: 10.5, 8.1, 19.6, 12.2, 19.5, 15.8 - Primary Balance (inc grants): (6.9), (6.6), (6.3), (11.1), (7.6), (15.1) - Overall Balance (excl grants): (9.6), (9.2), (9.1), (13.7), (10.2), (18.5) - /1 Staff's expenditure estimates include gradual clearance of outstanding domestic arrears. - Staff estimate: Feasible measures could improve the current primary balance by 5.5 percentage points of GDP by 2020 (via combinations of revenue and expenditure measures). - Fiscal Adjustments to the Primary Balance 2016–2020 (difference between baseline and adjustment scenario, in percent of GDP relative to baseline) - Revenue: 0.0, 1.2, 3.7, 3.8, 3.9 - Tax revenue: 0.0, 1.0, 3.4, 3.5, 3.6 - Tourism GST: 0.0, 0.0, 1.9, 2.0, 2.0 (raise rate to 15 percent) - Business Profits tax: 0.0, 0.9, 1.4, 1.4, 1.4 (broaden base and raise rate) - Other (including excise): 0.0, 0.4, 0.4, 0.4, 0.4 (Raise resort rent and loyalties; and/or excises) - Expenditure (excl interest): -0.3, -3.1, -3.1, -1.6, 0.4 - Current expenditures: -0.1, -0.4, -0.8, -1.4, -1.9 - Wages and allowances: 0.0, 0.0, -0.1, -0.3, -0.5 (contain wage bill) - Subsidies: -0.1, -0.2, -0.3, -0.5, -0.6 (cut electricity and food subsidies gradually) - Healthcare: -0.1, -0.1, -0.2, -0.4, -0.5 (contain healthcare costs) - Capital Expenditure: -0.2, -2.7, -2.3, -0.3, 2.3 (drop low viability projects, smooth scale up) - Total Savings: 0.3, 4.3, 6.7, 5.4, 3.4 - Primary Balance (Baseline): -10.6, -14.7, -14.5, -10.7, -4.9 - Primary Balance (Alternative Scenario): -10.3, -10.4, -7.8, -5.4, -1.5 - Current Primary Balance (Baseline): 1.8, 1.3, 0.5, 0.4, 0.7 - Current Primary Balance (Alternative Scenario): 2.0, 2.9, 4.9, 5.5, 6.4 ### Public financial management and public investment management (PIM) - 2014 PEFA and technical assistance confirm deep rooted expenditure control problems: unrealistic budgets, insufficient allocations, unenforced expenditure ceilings, reshuffling of spending between activities/ministries. - Completion of the Public Accounting System would address some problems; technical assistance recommends wide-ranging reforms including to public investment management. - Proposed institutional reforms: strengthen budgetary institutions; establish an economic management team (building on the Economic and Youth Council and including the MMA) to steer investment priorities and instill discipline; secure Majlis commitment to aggregate spending envelope and composition. - Box 3 (PIM): Key weaknesses and remedies: - Weak budgeting and planning: capital proposals not prioritized; capital budgets not aligned with implementation capacity; projects often partially funded; deferral of projects within year; new projects launched while ongoing projects left uncompleted. - Strengthen PIM: rigorous vetting and selection with feasibility studies; capital expenditure ceilings focused on finishing committed projects; adopt an annual budgeting and implementation process with mandatory pre-investment steps (idea, pre-feasibility study, feasibility study, design). ### Authorities’ views on fiscal management and PIM - Authorities expect infrastructure scale-up to generate growth enabling debt reduction in the medium term. - They do not see a need for higher tax rates but are open to base broadening and user fees for some infrastructure projects. - If revenues disappoint, they would defer lower priority capital spending. - Will continue public sector hiring restrictions and consider a public service review. - Considering better targeting of subsidies and streamlining healthcare. - Technical assistance is supporting strengthening of public financial management and roll out of public accounts system. - Authorities welcome staff’s proposal to quantify and present climate adaptation policies in each Budget. ### External sector assessment — key findings - Real exchange rate appreciation: real exchange rate has appreciated by 30 percent since the 2011 devaluation with a 10 percent increase over the past year. - Exchange rate regime: Since April 2011 devaluation Maldives has operated within a wide exchange rate band at 20 percent either side of Rf 12.85 per dollar; in practice rate has stayed at the weakest end of the band, operating like a de facto peg to the U.S. dollar. - Parallel foreign exchange market: - Active parallel market with a stable premium; premium has fluctuated from 2–15 percent since the GFC (2–6 percent in the past year). - Premium likely reflects oligopolistic market structure; many transactions conducted abroad and not through domestic banking system. - Parallel market premium and shortage of foreign exchange at the official rate give rise to exchange restrictions and multiple currency practices (MCP) subject to IMF approval under Article VIII Sections 2(a) and 3. - Current account and reserves: - Despite lower oil prices, the current account deficit is estimated to have widened in 2015. - Infrastructure spending could add 7–10 pps of GDP a year to the current account deficit. - Reserves are low relative to adequacy metrics. - Staff assessment: - External sector position looks moderately weak. - Standard indicators point to a moderately weak external position and moderately overvalued real exchange rate; loose fiscal stance explains most of the policy gap. - Corrective action needed: fiscal adjustment would help improve the external position and support the exchange rate. - A peg/stabilized regime is appropriate given small scale, high openness, dollarized nature of the economy, and large seasonal variation in revenues; medium-term review of the regime’s operation could be considered. ### Quantified external sector metrics and diagnostics - EBA-lite CA analysis (reported figures): - CA-Actual -8.0% - CA-Norm -4.0% - CA-Gap 4.0% - CA-Fitted -5.8% - Residual 2.2% - Policy gap 1.9% - Real Exchange Rate Gap 10.8% - Staff’s reserve adequacy framework for low income countries suggests optimum level of usable reserves for Maldives is in the range 3–7.5 months of imports for a fixed exchange rate regime. - Actual reserves—both usable and gross—are below the adequate level of import cover suggested by the range of metrics. ### Authorities’ views on external policy - Authorities committed to the stabilized exchange rate regime in the current band and agree improving the fiscal position is the best way to sustain it. - They consider the U.S. dollar link and stabilized regime appropriate; no exchange rate adjustment needed at present. - They view the January 2016 increase in the parallel market premium as likely seasonal and temporary; expect it to fall back to 3 to 4 percent, but see the premium as structural and not expected to be eliminated. - No change on Article VIII issues is expected until official reserves have increased and the fiscal deficit narrowed. *Source: IMF staff report excerpt (Maldives).* ### 34. Monetary policy was eased in 2015 to boost credit, reduce interest costs and lengthen ### _cr16135 - 34. Monetary policy was eased in 2015 to boost credit, reduce interest costs and lengthen ### Monetary policy easing and immediate effects - The MRR was halved to 10 percent. - Administered yields on treasury bills and bonds were cut to 3–4.6 percent. - With excess liquidity, banks and the pension fund have continued to purchase treasury bills and have taken up longer term bonds. - Credit growth has begun to accelerate. - Staff view: overall monetary stance appears relatively loose, especially given the expansionary fiscal policy setting and a wider current account deficit. - Staff recommendation: small step tightening of yields may be needed if financing shortfalls emerge; stand ready to increase the MRR if the external imbalance widens, capital outflows increase, and there is pressure on reserves. - Operational tool: open market operations could help mop up liquidity. - Longer term: once fiscal position improves, the MMA should move back to auctions and market based financing of government debt. ### Access to finance and inclusion challenges - Maldives ranks 116th on Doing Business indicators (World Bank) for access to finance by small and medium sized enterprises (SMEs). - Financial inclusion is challenging due to high cost of providing services to remote islands. - Authorities’ initiatives include: - concessional and Islamic financing to SMEs; - mobile banking services; - announced plan for sovereign guarantees for private sector loans in the tourism sector to rejuvenate investment in mothballed resorts. ### Staff’s position on sovereign guarantees and other credit facilitation measures - Sovereign guarantees to the private sector: - Staff views the scheme as a costly way to promote credit and adds to contingent fiscal costs. - Staff recommends dropping or strictly limiting the scheme. - If implemented, important features include: - ensure risk sharing with banks; - provide guarantees only on new loans (to residents); - impose fees to build a provisions fund against a call on guarantees. - Other ways to improve access to finance: - Credit growth has been subdued until recently given public financing needs, high NPLs, and limited information on counterparty risk. - Constraints could be eased by: - fully establishing the credit information bureau to aid risk assessment; - clarifying secured creditors’ legal rights regarding collateral plus more timely enforcement of the bankruptcy law to help banks more easily recover losses. - Encouraging savings: - Developing mobile money through the non-bank (mobile phones) should help facilitate financial intermediation across the country. - The World Bank FSAP development module may identify ways to strengthen the savings culture. ### Supervisory strengthening and financial stability risks - Compliance with prudential limits has improved and NPLs are almost fully covered. - MMA is increasing focus on operational, liquidity and market risks alongside credit risk and building analytical capacity. - Plans to relax single borrower limits for some infrastructure projects backed by collateral will need strict control. - Areas deserving particular attention: - risks from high exposures to the tourism sector; - lending concentration; - rapid growth of construction credit. - Given the high footprint of foreign banks in Maldives, authorities should access views of all home regulators. - Reconsidering license types for foreign exchange money changers could assist with prioritizing supervision over large players. - Regular data collection, analysis and closer supervision of large fx operators would assist policy decisions. - A safeguards assessment of the MMA was conducted in 2010; progress has been made on many recommendations, although the recommendation to enhance MMA’s autonomy and accountability through legal reform remains outstanding. ### Authorities’ views on monetary stance and guarantees - Authorities view the monetary policy stance as appropriate. - They consider the significant reduction in the MRR in 2015 helped turn around a lackluster domestic credit market; credit expansion in the second half of the year is viewed as positive. - MMA is mindful that credit growth should not accelerate too rapidly and will closely monitor any relaxation of single borrower limits on a case by case basis. - MMA is bolstering supervisory capacity and focusing more on operational and other risks. - Impact of lower yields on treasury bills and the bond market is yet to be fully observed; banks have plentiful reserves and tap auctions have typically been adequately subscribed. - Authorities note the sovereign guarantee scheme will be limited in aggregate size and plan to take staff’s views into account when designing the scheme. ### Building longer term resilience: climate change, resettlement, SEZs, and data - Geography drives high service provision costs and climate change adaptation needs. - Government measures and targets: - voluntary resettlement to regional hubs and improving transport connectivity to enable higher quality, lower-cost service provision; - investing in food and water security, infrastructure resilience, public health, coastal protection, fishing industry, waste management and renewable energy; - progressive reduction in thermal generated electricity—to raise renewable capacity—to provide 30 percent of daily peak load by 2018; - schemes for harvesting rain water for domestic purposes. - SEZs: - SEZs include a 40 percent limit on tourism activity to encourage mixed, labor-intensive sectors (off-port shipping services, IT and financial services). - Staff view: SEZs could help diversification but must be strictly ring-fenced so as not to undermine the tax base. - Safeguards: financial institutions in SEZs should face equivalent prudential, supervisory and reporting requirements as onshore (including anti money laundering provisions). - Data and statistics: - Data gaps could inhibit policy making. - Priority: passage of the statistics law (planned for 2017) to provide data collection powers to the MMA, Maldives Internal Revenue Authority and the statistics office; same requirements should apply to entities operating in SEZs. - Continued technical assistance in external statistics, national accounts and fiscal areas is a high priority. ### Staff appraisal: macro outlook and policy recommendations - Recent performance and risks: - Maldives developed rapidly to middle income levels driven by tourism; tourism slowed last year. - Current account deficit widened despite a positive terms of trade shock; inflation has remained contained and further pass through from lower oil prices is expected this year. - Infrastructure and debt risks: - Substantial infrastructure scale up could transform the economy but brings external financing risks. - After progress in reducing the deficit, the 2016 Budget is expansionary driven by capital spending. - Public debt will rise from already elevated levels, and prospective external borrowing indicates a high risk of debt distress. - Fiscal policy recommendation: - Durable fiscal adjustment is needed to prevent growing fiscal and external imbalances. - Staff would recommend a fiscal adjustment of around 5.5 percentage points of GDP by 2020. - Prioritize capital expenditures and accommodate only where feasibility studies show benefits outweigh costs. - Charge user fees for key infrastructure. - Leverage Maldives’ well administered tax system to generate higher revenues through base broadening and higher tax rates. - Firmer control of current spending is needed—including the wage bill and healthcare costs. - Move plans to better target subsidies forward. - Stronger public financial management, including over capital budgets, would raise probability of successful fiscal adjustment. - External position and exchange rate: - External position looks moderately weak; real exchange rate appreciated last year following U.S. dollar appreciation and reserves remain low relative to adequate levels. - Overall the external position looks moderately weaker than fundamentals and desirable policies; the real exchange rate moderately overvalued. - A tighter fiscal policy stance would improve the external position and support the exchange rate. - A stabilized exchange rate regime continues to be appropriate for Maldives. - Parallel market premium of greater than 2 percent, rationing of foreign exchange and an official exchange rate used by MMA for government transactions that may deviate by more than 2 percent from the prevailing market rate lead to multiple currency practices and exchange restrictions. - Fund staff does not recommend approval of these measures without a timetable for removal. - Monetary and financial policy support: - Current monetary stance appears relatively loose given expansionary fiscal policy. - Small step increases in administered rates may be called for and the MRR may need to be raised if capital outflow pressures emerge. - MMA’s focus on strengthening supervision beyond credit risk should continue. - Climate resilience and diversification: - Building climate change resilience, improving public service delivery and economic diversification are key medium term challenges. - Encouraging voluntary resettlement to regional hubs and better connectivity is an important adaptation strategy but will take many years. - Establishing a detailed national development strategic plan would help ensure investment programs are well coordinated and bring growth dividends. - Diversification through SEZs is welcome but strict ring-fencing of SEZ tax exemptions is needed to preserve the tax base. - Statistics work: - Work strengthening statistics is yielding good returns and should be continued. - A statistics law would help greatly improve private sector data provision. *IMF staff report excerpt.* ### 56. It is recommended that the next Article IV consultation be held on the standard 12- ### _cr16135 - 56. It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### Tourism performance and competitiveness - Tourism has "performed well compared to competitors but has slowed recently." - Tourist arrivals (year-on-year percent change): plotted 2007–2015 with Maldives above the weighted average of Mauritius, Seychelles, Bahamas and Barbados; GDP growth shown on RHS (figure note). - Tourism contributors to growth (2015 cf 2014 percentage change) by region: Total, Asia excluding China, Americas, Middle East, UN & others, United Kingdom, Europe excluding UK, Africa, Oceania, China (specific plotted values in figure). - Tourism bednights (000'): 2012: 6,451; 2013: 7,058; 2014: 7,290; 2015: 6,978; 2016 (proj.): 7,005; 2017 (proj.): 7,146; 2018 (proj.): 7,360; 2019 (proj.): 7,654; 2020 (proj.): 8,075. - Tourist arrivals (000'): 2012: 958; 2013: 1,125; 2014: 1,205; 2015: 1,234; 2016 (proj.): 1,251; 2017 (proj.): 1,299; 2018 (proj.): 1,338; 2019 (proj.): 1,392; 2020 (proj.): 1,468. - Tourism GST and corporate tax rates are described as "moderate compared to peers." - Bednights tax: equivalent to 2.25% (figure annotation). - Tourism receipts and nonfactor services, net (percent of GDP): reported in tables and figures (e.g., Table 1: 2012: 64.1; 2013: 68.5; 2014: 72.9; 2015: 69.7; 2016 (proj.) 69.4; subsequent projections provided). ### Exchange rate, inflation, and external competitiveness - "The real exchange rate has appreciated" — REER appreciation since 2014: Maldives shown among countries with positive REER appreciation (figure). - Nominal and Real Effective Exchange Rate, 2008–16: Index (2005 Jan=100) plotted; Euro/US Dollar Spot plotted on RHS. - CPI inflation (percent): plotted monthly 2008–2015; Table 1 period-average inflation: 2012: 10.9; 2013: 4.0; 2014: 2.5; 2015: 1.4; 2016 (proj.): 2.1; 2017 (proj.): 2.6; 2018 (proj.): 3.5; 2019 (proj.): 3.8; 2020 (proj.): 4.1. - End-of-period inflation (CPI-Male): 2012: 5.4; 2013: 3.1; 2014: 1.2; 2015: 1.9; 2016 (proj.): 2.0; 2017 (proj.): 3.2; 2018 (proj.): 3.6; 2019 (proj.): 4.0; 2020 (proj.): 4.2. ### External sector developments, reserves, and debt vulnerabilities - Goods balance "widened a little despite lower oil prices." - Gross reserves (millions of US$; e.o.p.) from Table 1: 2012: 305; 2013: 368; 2014: 605; 2015: 564; 2016 (proj.): 633; 2017 (proj.): 805; 2018 (proj.): 919; 2019 (proj.): 978; 2020 (proj.): 1,017. - Import cover of gross reserves (in months) projections: 2015 onwards plotted with values (figure). - Current account and capital projects (In millions of US$): historical series and projections plotted; Current account (ex CP) series shown 2005–2021 with projection. - Current account (in percent of GDP) from Table 4: 2011: -16.9; 2012: -7.4; 2013: -4.3; 2014: -4.1; 2015: -8.0; 2016 (proj.): -7.7; 2017 (proj.): -14.7; 2018 (proj.): -17.3; 2019 (proj.): -14.1; 2020 (proj.): -10.9. - External debt (in percent of GDP) from Table 4 (memo): 2011: 43.5; 2012: 35.2; 2013: 31.8; 2014: 33.4; 2015: 31.3; 2016 (proj.): 35.7; 2017 (proj.): 45.4; 2018 (proj.): 55.0; 2019 (proj.): 59.3; 2020 (proj.): 60.2. - PV of Debt-to-GDP ratio stress tests: projections and stress scenarios plotted; most extreme stress tests identified by shock type in figure notes (e.g., One-time depreciation, Terms shock, Exports shock). ### Fiscal developments and public debt - "The overall fiscal deficit is large." Table 1 (Central government finances, percent of GDP): - Revenue and grants: 2012: 26.2; 2013: 27.7; 2014: 32.1; 2015: 35.9; 2016 (proj.) 35.6; 2017 (proj.) 34.4; 2018 (proj.) 33.1; 2019 (proj.) 32.5; 2020 (proj.) 32.4. - Expenditure and net lending: 2012: 33.9; 2013: 35.2; 2014: 41.2; 2015: 44.3; 2016 (proj.): 48.9; 2017 (proj.): 52.5; 2018 (proj.): 52.0; 2019 (proj.): 48.4; 2020 (proj.): 43.2. - Overall balance (percent of GDP): 2012: -7.7; 2013: -7.4; 2014: -9.1; 2015: -8.4; 2016 (proj.): -13.3; 2017 (proj.): -18.1; 2018 (proj.): -18.9; 2019 (proj.): -15.9; 2020 (proj.): -10.9. - Primary balance (percent of GDP): 2012: -4.8; 2013: -4.9; 2014: -6.3; 2015: -5.9; 2016 (proj.): -10.6; 2017 (proj.): -14.7; 2018 (proj.): -14.5; 2019 (proj.): -10.7; 2020 (proj.): -4.9. - Public and publicly guaranteed debt (percent of GDP) from Table 1: 2012: 63.9; 2013: 64.8; 2014: 66.6; 2015: 73.1; 2016 (proj.): 83.1; 2017 (proj.): 96.5; 2018 (proj.): 109.0; 2019 (proj.): 117.5; 2020 (proj.): 120.8. - Central government expenditure composition (percent of GDP, Table 2b): - Wages and allowances: 2012: 11.8; 2013: 13.1; 2014: 13.1; 2015: 13.6; 2016 (proj.): 13.4; 2017 (proj.): 13.4; 2018 (proj.): 13.0; 2019 (proj.): 12.7; 2020 (proj.): 12.4. - Capital expenditure: 2012: 7.5; 2013: 4.9; 2014: 5.5; 2015: 8.1; 2016 (proj.): 19.6; 2017 (proj.): 12.2; 2018 (proj.): 15.8; 2019 (proj.): 15.6; 2020 (proj.): 11.7. - 2016 Budget "includes very large capital spending" and is adding to elevated public debt and external debt. ### Money, credit, and financial sector - Broad money growth (year-on-year percent change) picked up; Table 3 broad money (% change): 2012: 6.4; 2013: 16.8; 2014: 14.7; 2015: 13.6; 2016 (proj.): 11.1; 2017 (proj.): 9.2; 2018 (proj.): 10.1; 2019 (proj.): 10.8; 2020 (proj.): 11.1. - Domestic credit (annual percent change) series from Table 3: 2012: -2.4; 2013: 3.9; 2014: 4.7; 2015: 16.0; 2016 (proj.): 11.7; 2017 (proj.): 9.0; 2018 (proj.): 8.6; 2019 (proj.): 8.9; 2020 (proj.): 8.5. - Private sector credit remains "low compared to economies at similar income levels"; private credit percent of GDP plotted versus nominal GDP per capita. - Sectoral composition of private credit, 2015 (percent of total credit): Tourism: 40.0; Commerce: 17.0; Construction: 16.1; Real estate and others detailed in figure. - Commercial banks' reserves (percent of total deposits) plotted: Reserves and MRR series December 2012–December 2015. - Banks have "structurally substantial excess liquidity—to deal with unexpected liquidity shocks." ### Financial soundness and business environment - System-wide NPLs and capital adequacy slowly improved; profitability improved since the GFC. - Bank indicators (Table 6, selected): - Regulatory capital to risk-weighted assets: 2007: 15.4; 2008: 21.0; 2009: 24.7; 2010: 28.9; 2011: 30.3; 2012: 35.8; 2013: 34.0; 2014: 44.5; 2015Q1: 44.5; 2015Q2: 44.3; 2015Q3: 42.0. - Nonperforming loans (gross) to total loans (gross): 2007: 1.7; 2008: 8.9; 2009: 12.7; 2010: 17.1; 2011: 19.4; 2012: 21.1; 2013: 16.7; 2014: 17.4; 2015Q1: 15.9; 2015Q2: 20.1; 2015Q3: 15.3. - Return on assets: 2007: 5.3; 2008: 3.4; 2009: 2.2; 2010: 2.0; 2011: 2.6; 2012: 2.4; 2013: 5.1; 2014: 4.6; 2015Q1: 2.2; 2015Q2: 3.1; 2015Q3: 3.3. - Assets of Banks (rufiyaa billions): 2007: 18.3; 2008: 22.7; 2009: 25.1; 2010: 25.9; 2011: 28.7; 2012: 27.6; 2013: 32.7; 2014: 37.0; 2015Q1: 38.7; 2015Q2: 39.8; 2015Q3: 40.2. - Doing Business indicators: Maldives "remain weak" with little change year-on-year; World Bank Doing Business rankings compared to other tourist-dependent economies presented for 2014 and 2015. ### Macroeconomic projections (baseline and staff scenarios) - Table 1 (Baseline scenario) selected projections: - Real GDP growth (annual percent): 2012: 2.5; 2013: 4.7; 2014: 6.5; 2015: 1.9; 2016 (proj.): 3.5; 2017 (proj.): 3.9; 2018 (proj.): 4.6; 2019 (proj.): 4.7; 2020 (proj.): 4.8. - Gross international reserves (in millions of US$, e.o.p.): see Table 1 values (2012–2020) listed above. - Current account (percent of GDP) and other balance of payments items given in Table 4. - Staff’s Recommended Adjustment Scenario (Table 5) provides alternative projections: - Real GDP growth: 2016 (proj.): 3.5; 2017: 3.9; 2018: 4.6; 2019: 5.5; 2020: 5.5. - Central government finances (percent of GDP) under adjustment scenario: Revenue and grants 2016: 35.9; 2017: 35.6; Expenditure and net lending 2016: 44.8; 2017: 48.5; Overall balance 2016: -13.0; 2017: -13.8; Primary balance 2016: -10.3; 2017: -10.4. - Gross international reserves (millions of US$; e.o.p.) under adjustment scenario: 2016 (proj.): 305; 2017 (proj.): 368; 2018 (proj.): 605; 2019 (proj.): 564; 2020 (proj.): 630; longer-run projections 807, 924, 1,067, 1,243 shown in Table 5. ### Key fiscal and public financial management recommendations (Public Financial Management Reform Plan 2015–2018) - Establish clear responsibilities and high-level coordination: - Convene high level discussion among public financial management agencies to establish agreement on the reform plan, monitoring, priorities and responsibilities. - Develop capacity for analysis of budget, fiscal framework and audit reports. - Strengthen budget formulation and realism: - Improve policies for setting expenditure ceilings, including identifying multi-year expenditure commitments. - Gain commitment to realistic expenditure ceilings at line ministry and agency level at the beginning of the budget process. - Strengthen information provision for line ministries and agencies on actual, priority and committed expenditures. - Closer coordination between recurrent and capital budgets including unified expenditure plans together with financing plans for capital expenditures. - Improve cash management and arrears control: - Review baseline expenditures as an input for cash management. - Improve reporting and monitoring of budget execution, including commitments. All line ministries to implement commitment control. - Develop policy on payment of arrears and preventing their recurrence. - Strengthen capacity and coordination to improve cash flow forecasting. - Develop medium-term fiscal and debt frameworks: - Develop a medium term fiscal plan in line with the Fiscal Responsibility Law. - Strengthen capacity and develop the analytical information for a medium term framework including projecting credible aggregate fiscal parameters; develop a simple medium term model. - Update the debt strategy in line with the Fiscal Responsibility Law; gather reliable data (guarantees, arrears, domestic securities); make debt data public; increase capacity for debt sustainability analysis; publish interim targets for debt and current primary and primary balance. - Expand primary domestic debt market through longer term instruments and develop a secondary market. - Strengthen accounting, reporting, audit and monitoring across local government and SOEs: - Document accounting and reporting frameworks; introduce streamlined reporting requirements and formats. - Use the Chart of Accounts in consultation with key data users; roll out the remainder of the Public Accounting System. - Fuller reporting including of major deviations in budget and financial statements. - Review legislation and clarify responsibilities for internal and external audit; develop capacity and make external audits timelier. - Political commitment: "Commitment at the political level by the Majlis (Maldives’ parliament) to the spending envelope and the composition of spending in addition to the budget aggregate would be important." - Note: "The Reform Plan was developed by the IMF and World Bank following the 2014 PEFA." *Source: Maldives: IMF staff report content as provided in the supplied PDF content unit.* ### Appendix I. The Benefits and Costs of Scaling Up Using a Debt ### Appendix I. The Benefits and Costs of Scaling Up Using a Debt ### Investment growth model: evidence and assumptions - Airport expansion can have substantial growth effects by expanding capacity, lowering airfares, and boosting tourism demand. - Punta Cana example: rising from 850 thousand tourists (35 percent of all arrivals in the country) in 2000 to nearly 3 million (65 percent of arrivals) in 2014 (an increase of almost 240 percent). - Culiuc (2014) finds direct flights to small islands associated with tourist arrival increases ranging between 20–80 percent. - Acevedo et al (2015) finds increasing the number of flights to tourist destinations is the most effective way to boost tourist arrivals. - The DIG (debt investment growth) model for Maldives accounts for: highly open economy, high import intensity, and the size and pace of investment plans; benefits concentrated in tourism and reliant on supporting FDI in resorts and transportation. - Uncertainty is captured via alternative assumed returns on public capital: 15 percent, 25 percent (baseline), and 50 percent (higher efficiency). ### Growth outcomes (model results) - Baseline (25 percent return): suggests a temporary but sustained increase in real growth rates of ½–¾ percentage points (Figure A, blue lines). - Higher efficiency (50 percent return): can achieve higher growth than baseline. - Low efficiency (15 percent return): much smaller growth effects. ### Public finance impact and fiscal trade-offs - Financing the scaling up would require substantial fiscal adjustment: - An increase in tax rates of more than 6 percentage points to 19 percent would be necessary to finance the scaling up and limit the impact on the deficit in the absence of further adjustments, even allowing for a substantial amount of concessional debt. - To limit the increase in taxes to 15 percent would require a temporary cut in transfers of 2.5 percent of GDP. - Authorities’ plans are more heavily weighted to external debt than suggested by this model. - Scaling up of public investment results in large increases in debt; poor public investment efficiency would raise debt without meaningful growth gains. ### Implementation and private-sector confidence - Sound project implementation is crucial: - Increasing the return on public investment from 25 to 50 percent could increase output growth by an additional 0.6 percentage points for 3–4 years after completion, and by around 0.3 percentage points for 6–7 years. - With higher efficiency, private investment, private capital, and private consumption would increase substantially over the medium-to-long term. - Poor project management leading to lower public investment efficiency would not add much to growth but would drive debt higher. ### Charts and indicators referenced - Chart sets compare Real GDP Growth (y/y percent) and Scaling Up of Public Investment (In percent of GDP) under 15% Return, 25% Return, and 50% Return scenarios. - Public finance impact charts illustrate Overall Fiscal Deficit (In percent of GDP) and Taxes and Transfers (In percent) under scenarios of Limited Cut in Transfers and Larger Cut in Transfers. - Sources noted for charts: Maldivian authorities; and IMF staff estimates. --- ### Appendix II. Maldives: Tax System – Keep it Simple, Keep it Fair ### Current assessment - Maldives tax system compares favorably to South Asian economies and Caribbean islands: relatively new, small number of broad-based taxes, efficient administration, strong revenue collections, and not distorted by tax incentives. - As the tax system matures, maintaining simplicity, fairness, and effectiveness is emphasized; avoid introducing tax incentives due to long-term revenue risks. ### Risks from Maldives Special Economic Zones Act 2014 (SEZ) - SEZ sets unlimited discretionary space for tax incentivizing of investment; planned SEZ types include free trade, offshore financial services, industrial, export processing, and ports SEZs. - Incentives potentially include wide-ranging exemptions from import duty, BPT, GST, and withholding taxes, and concessions on expatriate workers and land taxes. - Shortcomings identified: - Unlimited room for discretion: roles, accountability, reporting, and oversight frameworks for issuing, negotiating, and evaluating incentives are not clearly defined. - Unlimited room for tax incentivizing: the act does not define the nature or limits of tax incentives; broad exemptions, holidays, rate reductions, and deductions could affect BPT and GST legal frameworks. ### Potential systemic consequences of discretionary SEZ incentivizing - Discretionary SEZ incentivizing may: - Invite competition for customized tax regimes, creating carve-outs for special interest groups. - Lead to annual injections of new tax incentives, eroding the tax base and reducing revenue potential. - Make the tax system more complex, unpredictable, and unstable, necessitating alternative revenue sources, higher tax rates, and new taxes. ### Recommendations to tighten SEZ framework - Consider tightening SEZ legislation to limit discretionary space and protect the integrity of the tax system, specifically: - i) Define roles, responsibilities, accountability and reporting framework for agencies involved in tax incentivizing decisions. - ii) Use alternative incentive mechanisms rather than tax legislation. - iii) Establish a gatekeeper role for ministry of finance and treasury for any tax incentivizing decisions to protect the tax system’s integrity. - iv) Quantify and report all tax incentives as part of the budget submission. - v) Establish and enforce quantitative ceilings for tax incentives, if such incentives are considered. ### Lessons: pros and cons of tax incentives - Pros - FDI injecting expertise and resources - Development for non-traditional exports and industries - Cons - Erode tax base resulting in a direct loss of revenue - Do not matter for investment if overall economic factors are conducive - Business investment decisions are based on predictability, stability and transparency of the tax system rather than tax burden - Distort allocation of resources - Enable corruption by opening space for discretion and non-transparent decision making - Complicate tax system, make administration costly, and lead to rates increase on a narrower base - Once precedent is created it spreads to the system - Source for lessons: IMF FAD TA (2015) ### Tax revenue performance and productivity (charts referenced) - The tax base has broadened with recent policy measures. - Maldives tax revenue is productive and compares well regionally (including the Caribbean). - Charts referenced include Maldives Tax Revenue (In percent of GDP) over time and Tax Revenue Productivity measures for Corporate Income Tax and Tourism GST. --- ### Appendix III. Financial Inclusion in the Maldives ### Context and comparative performance - Financial Inclusion (FI) is challenging due to high transaction and sunk costs of serving sparsely populated and remote islands. - Maldives compares relatively favorably on geographical measures (number of bank branches and ATMs per 1,000 km2) and scores relatively well on some regional FI assessments. - When measured per 100,000 adults, FI indicators are pulled down by high population density in Malé and larger islands, highlighting low FI on small remote islands. ### Recent developments and initiatives - Bank of Maldives expanded FI via dhoni banking units to remote islands and announced plans to provide banking services to all islands by 2017. - FIRST Initiative launched “Enabling a Non-Bank Mobile Money Solution” targeting populations in outer islands. - Authorities scaling up support to SMEs via concessional and Islamic financing, reviving small-scale industries, encouraging female labor force participation, and prioritizing government contracts to SMEs. ### Remaining challenges - Credit remains expensive and exclusive because of: - Limited information about counterparty risk (coverage of the credit registry is limited). - Lack of accurate information on collateral (absence of an electronic collateral registry) and complexities in the legal framework. - Limited credit diversification; businesses outside perceived profitable sectors face difficulty obtaining credit. - Technology adoption underutilized: internet banking exists, but mobile banking is nascent and telecom connectivity is underused for banking services. ### Recommended measures to improve inclusion - Revamp the credit registry. - Push for technology solutions like mobile banking to overcome geographic constraints. - Implement schemes to promote credit access to women and youth via SME development. - Strengthen financial literacy programs and conduct surveys to understand minority group needs and constraints. - Leverage existing networks (e.g., postal system) for financial awareness. --- ### Appendix IV. Maldives: Risk Assessment Matrix ### Upside scenarios and policy responses - Upside outcomes - Higher tourism growth could provide short-term breathing space to implement fiscal measures. - Decisive and durable fiscal measures together with strengthened public financial management would reduce fiscal and external pressures. - Successful completion of infrastructure projects would add to potential growth at least temporarily. - Upside triggers identified 1. Tourism demand rebounds more strongly than expected: redevelopment of the airport could significantly raise capacity and catalyze investment. Likelihood: Low. Impact: High. 2. Decisive and durable fiscal consolidation efforts: improvements in public financial management and prioritized ramp-up in capital expenditures with offsetting consolidation. (Likelihood/Impact context presented in matrix.) ### Downside scenarios and policy responses - Downside risks - Baseline projections show debt on an unsustainable path; investment plans need prioritization, sequencing, and careful management to avoid debt distress. - Domestic and external shocks would exacerbate vulnerabilities, deteriorate the fiscal position, pressure the parallel market premium, and erode MMA official reserves. - If risks materialize, accelerate fiscal adjustment, abate investment plans, and implement tough durable expenditure controls. - Financial stability risks require close monitoring; bank strains would necessitate a range of resolution measures including independent external assessment. - Risk severity in matrix: Medium likelihood / Medium impact is indicated for several downside items. ### Specific risks detailed 1. Political tensions escalate and dent tourism. - Security advisories usually apply to Malé with airport and resorts remaining open; some tourist cancellations followed November’s state of emergency. - Further heightened tensions could prompt additional declines in arrivals. - Likelihood: Medium. Impact: Low. 2. Global risks: structurally weak growth in China (medium term), sharp slowdown in China in 2015/16, and persistent U.S. dollar strength (short term). - Tourism driven increasingly by arrivals from new markets such as China; slowdown affecting Chinese middle class and outbound travel would negatively impact Maldives arrivals. - Further U.S. dollar appreciation against the euro could dampen growth; real effective exchange rate has risen as the US dollar appreciated, possibly reducing competitiveness. - Maldives is a high-end destination with around 60 percent of resorts in the 5 star and plus category; tourist demand likely relatively price and income inelastic, though the growing middle-market is more price sensitive. - Likelihood: High / Medium. Impact: High. *Source: _cr16135 - Appendix I. The Benefits and Costs of Scaling Up Using a Debt* ### 3. Policy slippages. ### 3. Policy slippages. ### Fiscal vulnerabilities and public investment - Stronger public financial management and investment management needs to be in place to help manage fiscal vulnerabilities. - The large public investment program is substantially adding to downside risks. ### Risk Assessment Matrix (RAM) — staff guidance - The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - Relative likelihood definitions (staff’s subjective assessment): - “low” = probability below 10 percent - “medium” = probability between 10 and 30 percent - “high” = probability between 30 and 50 percent - The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. - Non-mutually exclusive risks may interact and materialize jointly. - Timing labels: - “Short term” = could materialize within 1 year - “Medium term” = could materialize within 3 years ### Fund relations — key financial positions (As of February 29, 2016) - Quota: 21.20 (SDR Million) - Percent Quota: 100.00 - Fund holdings of currency (exchange rate): 16.40; Percent Quota: 77.34 - Reserve Tranche Position: 4.80; Percent Quota: 22.66 - SDR Department: - Net cumulative allocation: 7.69 (SDR Million); Percent Allocation: 100.00 - Holdings: 3.66; Percent Allocation/Holdings: 47.54 - Outstanding Purchases and Loans: - ESF Arrangements: 1.74 (SDR Million); Percent Quota: 8.22 ### Latest financial arrangements (selected) - Stand-By: Arrangement Date 12/04/2009; Expiration Date 12/3/2012; Amount Approved (SDR million) 49.20; Amount Drawn (SDR Million) 8.20 - ESF: Arrangement Date 12/04/2009; Expiration Date 12/3/2011; Amount Approved (SDR million) 8.20; Amount Drawn (SDR Million) 2.05 ### Projected payments to Fund (SDR million; based on existing use of resources and present holdings of SDRs) - Forthcoming 2016 2017 2018 2019 2020 - Principal: 0.41 0.41 0.41 0.41 0.1 - Charges/Interest: 0.00 0.01 0.00 0.00 0.00 - Total: 0.41 0.42 0.41 0.41 0.11 ### Exchange arrangements and external sector practices - Since April 2011, the rufiyaa has floated in a band of 20 percent on either side of Rf 12.85 per dollar. - In practice, the rufiyaa has been virtually fixed at the band’s weaker end of Rf 15.42 per dollar. - De jure exchange rate arrangement: a pegged exchange rate within horizontal bands. - De facto exchange rate arrangement: classified as a stabilized exchange rate arrangement. - Maldives continues to avail itself of the transitional provisions of Article XIV but no longer maintains any measures under this provision, and has not yet accepted the obligations of Article VIII, Sections 2, 3, and 4. - The MMA rations its supply of foreign exchange to commercial banks, channeling current international transactions to the parallel market where transactions take place at an exchange rate that deviates by more than 2 percent from the prevailing market exchange rate. - The greater than 2 percent spread gives rise to multiple currency practice subject to IMF approval under Article VIII, Section 3 and also to an exchange restriction under Article VIII, Section 2(a). - The official exchange rate used by the MMA for government transactions is calculated based on the mid-point of the weighted average of the buying and selling rates of foreign exchange transactions conducted by commercial banks one day earlier. ### Last Article IV consultation - The 2014 Article IV consultation was concluded by the Executive Board on February 11 2015. ### Technical assistance — areas and recent activity - FAD: - Main engagement: Public Expenditure and Financial Accountability (PEFA) assessment and TA for cash management. - Joint IMF/WB-led PEFA assessment: February 2014. - Public Financial Management Reform Plan (PFMRP) developed: June 2014. - Three missions on cash management since FY14; updated action plan in August 2015 to make the cash management unit functional, start using the cash flow forecasting model and implement a commitment control system. - September 2014: review of Chart of Accounts (CoA) and action plan; coordinated with STA mission on mapping government COA to GFSM 2014. - LEG: - October 2003: TA on revision of the Maldives Monetary Authority Act (MMA Act). - Missions in March and September 2005, April 2006 to revamp banking law. - August 2009: assistance on MMA Act (jointly with MCM). - February 2011: payments law mission. - October 2010: AML/CFT assessment; May 2012: desk-based review of draft AML/CFT law. - 2014–2015: advice on the Special Economic Zones Law, offshore banking legislation and deposit insurance. - MCM: - Multiple missions 2006–2015 on monetary operations, liquidity management, financial market development, banking supervision, debt markets, foreign exchange operations, crisis preparedness and management, bank restructuring, and reserve management. - Mission confirmed for late March 2016 to advise on foreign exchange and monetary policy operations. - STA: - Missions on money and banking statistics (May 2007), balance of payments, government financial statistics, monetary and financial statistics, national accounts, and price statistics across 2011–2015. - Between March 2013 and January 2016, STA fielded eight TA missions on balance of payments statistics (project funded by Government of Japan). - Further TA mission on balance of payments statistics scheduled for March 2015. ### Safeguards assessment (MMA) - Assessment concluded in March 2010. - Actions taken: appointment of an external auditor; strengthened controls over foreign payments through automation of the authorization process; appointment of a Chief Internal Auditor; continued improvement of internal audit capacity. - Legal framework: amendments to the MMA Act were drafted in 2011 and the MMA Act was amended in 2015. - Outstanding safeguards recommendations not yet incorporated: establishment of an Audit Committee; limits on credit to government; safeguards for personal autonomy of Board members. ### IMF–World Bank Joint Management Action Plan (As of February 2016) - World Bank Group Systematic Country Diagnostic (2015) identified three priority areas: - Enhancing opportunities in tourism and fisheries for the local population. - Enabling opportunities for the creation of new sources of inclusive growth. - Enhancing the efficiency and efficacy of public resource management and reducing macro-fiscal risk. - Country Partnership Framework (CPF) FY16-19 (to be presented to the Board in April 2016) proposes selective engagement oriented to enhance economic participation of Maldivians and deepen interventions in: - Education, public finance management, environment and natural resource management, renewable energy. - Cross-cutting themes: Youth, gender, governance, climate resilience. - World Bank programs: - Public Financial Management Systems strengthening project for FY 15-20 — objective: enhance budget credibility, transparency, and financial reporting of central government finances; focus on PFM environment and budget execution. - Separate Bank-funded project supports Auditor General’s office: updating audit law, performance audit pilots, training staff on auditing consolidated financial statements using international audit standards. - Bank-led initiatives to improve targeting of universal subsidies and reform social protection: - Health: technical support focused on achieving operational savings for Aasandha; substantial capacity building of NSPA required. - Poverty: support for design of a new Household Income and Expenditure survey planned to start field operations in March 2016; survey completion expected by November 2016 to support a new national poverty line. - Proxy Means Testing: support to NSPA to develop targeting mechanisms for electricity subsidy and other social safety net programs; PMT formula to be updated once new HIES data is available. - Appendix I (selected planned activities and dates): - Joint Bank-Fund Debt Sustainability Analysis: April 2016 - Delivery dates and approvals listed for various Bank projects (examples include approvals in June 2008, Nov 2012, April 2013, June 2014, March 2015, October 2012; delivery dates FY 16, FY 17, FY 18 noted). ### Relations with the Asian Development Bank (As of August, 2015) - ADB country operations business plan (COBP), 2015–2017 approved in February 2015; abridged interim CPS prepared for 2016; full CPS spanning 2016–2020 to be prepared in 2016. - Maldives eligible for resources from the Asian Development Fund: - Indicative resources available during 2016−2018 amount to $25.36 million. - The Maldives was eligible for a 100 percent grant share of country allocations in 2015. - Final country allocations for 2017 and 2018 subject to available ADF grants and concessional ordinary capital resources and the outcome of country performance assessments; proportion of grants for 2016–2018 to be determined by future annual debt distress classifications. - ADB will seek co-financing where possible during COBP period. - Indicative assistance pipeline highlights: - Lending product changes: Kulhudhuffushi Harbor Expansion Project funds reduced from $12.68 million to $9.69 million for 2016; L. Gan-Fonadhoo Major Cross-Roads Project moved to 2018 and renamed L. Gan-Fonadhoo Community Connectivity Project. - Non-lending program: Improving Business Climate TA renamed to Supporting Project Development and Information Management; planned resource request $400,000 from Japan Fund for Poverty Reduction (on standby pending funding decision). - 2017: project preparatory TA proposed for the Township Development Project for $1,000,000. - 2018: capacity development TA proposed to attach to L. Gan-Fonadhoo Community Connectivity Project for $1,000,000. - Non-sovereign operations constraints: - Lack of effective convertibility of the rufiyaa. - Weak sovereign rating. - Generally weak private sector capacity in financial management and accounting and limited availability of skilled workforce. - ADB will consider scoping specific areas to support private sector during 2016–2018 and discuss possible non-sovereign operations with the government where feasible. *Source: _cr16135 - 3. Policy slippages.* ### Appendix II. ADB Updated Interim Country Partnership Strategy Results Framework ### Appendix II. ADB Updated Interim Country Partnership Strategy Results Framework ### Statistical issues: assessment and data gaps - General assessment: Macroeconomic statistics have improved with technical assistance from STA and the Asian Development Bank (AsDB). Data are broadly adequate for surveillance (Category B) but significant gaps remain affecting balance of payments, government finance, and national accounts statistics. - Real sector: - National accounts: Annual national accounts available with considerable lag; authorities have begun publishing quarterly GDP data. GDP estimates from production and expenditure approaches are inconsistent. - Base year: Constant price estimates use base year 2003; recent structural changes are not reflected in base period weights. - Assistance: AsDB assisted setting up a framework for more comprehensive national accounts; STA assisted improving annual production and expenditure GDP measures and developing quarterly GDP series. - CPI: Rebased to June 2012=100 with STA assistance; weights based on the 2012 household income and expenditure survey. - Fiscal sector: - GFS Yearbook: Latest published general government data are for 2011. - Monthly fiscal data: Monthly revenue and expenditure data available but the reporting system is new and reliability untested; weak consistency with below-the-line financing numbers from monetary authorities. - External debt: Data subject to reconciliation with creditors. - State enterprises: Data on operations of state enterprises are limited. - Financial sector: - Monetary statistics: APD receives an electronic report every two weeks covering balance sheets of the MMA and commercial banks. Summary data published in MMA’s Monthly Statistics, QEB and AR. - Inconsistencies exist between monetary and fiscal data regarding fiscal deficit financing due to timing and coverage. - MMA uses standardized report forms (SRFs) for central bank and other financial corporations. An integrated monetary database that meets needs of the MMA, STA, and APD is operational. - External sector: - Balance of payments: MMA compiles BOP data annually; coverage has improved but remains limited in some areas and recent TA recommendations are yet to be implemented. - Travel credits and services: Travel credits (receipts) and other services items estimated using tourism GST receipts and withholding tax on services by nonresidents; does not capture all cross-border services. Ministry of Tourism survey should be used to validate travel credit estimates. - FDI surveys: First inward FDI survey in June 2013 and a second in 2015; a new regulation should address low response rate. FDI source data sufficiently detailed for participation in IMF’s Coordinated Direct Investment Survey (CDIS). - Other private financial flows: Estimated on CPIS and BIS data; coverage needs improvement. - International investment position (IIP): A revised and more complete IIP dataset consistent with the financial account will be disseminated in April 2016. - External debt reporting: Quarterly external debt and debt service available for government and monetary authority and to some extent for banking sector and state enterprises at annual consultation missions; no data for the nonfinancial private sector; external debt data not reported to QEDs. - Reliability: Despite improvements, BOP data reliability is uncertain due to many transactions occurring outside the country and lack of international counterparty data on tourism services to validate revenue estimates. - Reserves and foreign currency flows: - Official reserve assets reported every two weeks with a (variable) one-week lag. - Predetermined foreign currency outflows (mainly debt service) are known and reported to APD at annual Article IV missions; other movements of foreign currency assets are not identified. ### Data standards, reporting, and participation - GDDS: Maldives has participated in the General Data Dissemination System (GDDS) since October 14, 2011. - ROSC: No data ROSC available. - Reporting to STA: Authorities report macroeconomic data regularly and generally timely for publication in the IFS, BOPSY, and GFSY. ### Table of Common Indicators Required for Surveillance (as of April 6, 2016) - Exchange Rates: Latest observation 03/31/2016; Date received 04/06/2016; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Latest observation 03/31/2016; Date received 04/06/2016; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D. - Reserve/Base Money: Latest observation 03/24/2016; Date received 03/31/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Broad Money: Latest observation 03/24/2016; Date received 03/31/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Central Bank Balance Sheet: Latest observation 03/24/2016; Date received 03/31/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Consolidated Balance Sheet of the Banking System: Latest observation 03/24/2016; Date received 03/31/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Interest Rates: Latest observation 04/05/2016; Date received 04/06/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Consumer Price Index: Latest observation 01/31/2016; Date received 03/07/2016; Frequency of Data W; Frequency of Reporting W; Frequency of Publication M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Latest observation 2014; Date received 11/30/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - Revenue, Expenditure, Balance and Composition of Financing – Central Government: Latest observation 2014; Date received 11/30/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - Stocks of Central Government and Central Government-Guaranteed Debt: Latest observation 2014; Date received 11/30/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - External Current Account Balance: Latest observation 2014; Date received 10/28/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - Exports and Imports of Goods and Services: Latest observation 11/30/2015; Date received 03/07/2016; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - GDP/GNP: Latest observation 2014; Date received 10/30/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - Gross External Debt: Latest observation 2014; Date received 10/30/2015; Frequency of Data A; Frequency of Reporting M; Frequency of Publication M. - Frequency codes: Daily (D); Weekly (W); Monthly (M); Quarterly (Q); Annually (A); Irregular (I); Not Available (NA). - Notes: Includes reserve assets pledged or otherwise encumbered as well as net derivative positions. Interest rates include market-based and officially determined rates. Fiscal financing includes foreign, domestic bank, and domestic nonbank financing. General government definition provided. Stocks include currency and maturity composition. ### Debt Sustainability Analysis (DSA) — key findings and risks - Update: DSA updates the March 2015 DSA. External risk rating elevated to a high risk of debt distress based on assessment of public external debt and large prospective increases in capital spending. - Overall risk: Assessment of overall risk of debt distress is high and reinforced by significant vulnerabilities related to domestic debt. - 2016 Budget impact: Authorities’ 2016 Budget projects a substantial increase in capital spending financed wholly by external debt (with no offsetting fiscal measures). This will add to debt and foreign currency risk and change composition of Maldives debt. Execution rate of capital projects is highly uncertain; under-execution is likely but even accounting for under-execution debt still rises sharply and cost overruns are possible. - Threshold breach: The authorities’ 2016 Budget entails a large increase in external debt which would breach the PV of external debt to GDP threshold. - Key risks that could trigger debt distress: - Fiscal policy mistakes. - Shocks to tourism exports or foreign direct investment. - Policy recommendation summary: - To stabilize and then reduce public debt ratios, staff proposes greater prioritization of capital expenditures, additional fiscal revenue and expenditure measures, and public financial management reforms. - Adjustment measures—illustrated by staff’s illustrative scenario—are needed to reduce the probability of debt distress while accommodating an increase in capital expenditure. ### Recent debt developments and structure - Public debt trends: - Total public debt has risen rapidly since the 2004 tsunami and is above the 60 percent limit in the Fiscal Responsibility Law as of end-2015 at around 73.1 percent of GDP. - Increase initially reflected tsunami-related expenditure; more recently driven by additional recurrent spending on wages, social welfare, subsidies, and capital spending on infrastructure scale up. - Under the baseline scenario, public debt would remain on a rising path over the medium term. - Debt holders and financing: - Public debt is held mainly by domestic banks, pension funds, the Maldives Monetary Authority (MMA), and official multilateral and bilateral creditors. - Economy has relied heavily on issuance of treasury bills, monetization, and external borrowing to finance deficits. - Domestic arrears likely declined significantly in 2015 (aided by better revenue performance); DSA baseline assumes these are cleared over a period of three years. - External debt: - External debt ratio declined since the global financial crisis due to net repayments of public and privately guaranteed external debt and private external debt between 2010 and 2015. - Private sector external debt data are subject to large errors with likely further revisions. - Combined private external debt and total public debt estimated at about $ 2.6 bn (82.3 percent of GDP) in 2015. ### PRGT eligibility and financing implications - PRGT eligibility: - Maldives continues to be PRGT eligible as of the last review in June 2015. - Although Maldives meets the income criterion by a large margin, short-term macroeconomic vulnerabilities (risk of income decline and loss of market access from elevated debt) kept it from graduating from PRGT eligibility. - Broad alignment with IDA practices and small island economy exception mean Maldives remains an IDA-only country receiving most assistance from IDA on grant terms. - Concessional financing importance: - With medium-term risks like planned investment scale up, slowdown in China (largest tourism market), and potential climate change costs, concessional financing will continue to be a key source of external financing given the existing very high debt. ### Macro assumptions underlying the baseline - Baseline: Built on current policies including staff’s assessment of the Authorities’ 2016 Budget. Staff note the budget projects unrealistically low current expenditures and an unprecedentedly large rise in capital spending. Baseline does not include SEZ revenues or compensation from arbitration ruling over airport concession. - Key numeric and qualitative assumptions and projections: - Real GDP growth: Growth remains subdued in 2016 and 2017 and averages 4.4 percent over 2021–35 (slower than the past ten-year average around 6.5 percent). Staff factor in a ½ percent of GDP per year increase in medium-term potential growth from tourism development. - Inflation (GDP deflator): Remains low over next two years reflecting lower oil prices and weaker global commodity prices, partly offset by higher import duties; rises to around 3.2 percent in medium term. - Current account: Non interest current account deficit balloons from 2016 reflecting higher imports for infrastructure projects; deficit narrows once large projects are completed but averages 7.5 percent of GDP over 2020–2035. - Reserves: Longer-term financing pressure from maturing infrastructure loans results in reserves levels dwindling to be negligible in terms of import cover by the end of the forecast. - Fiscal primary balance: Under the baseline, primary deficit widens substantially from 2015 to 2016 due to capital projects and social welfare spending; after completion of projects the primary deficit remains well above the level that would stabilize debt. - Financing and interest rates: - Historically, bulk of deficit financing met from domestic sources (domestic banking system and pension fund). - Government replaced auction system with a 'tap system' mid-2014 and lowered rates to a range of 3.5–4.6 percent across maturities. - Staff assume Maldives yields are high and rise over the forecast horizon with global rates expected to rise. - New external debt: DSA assumes external disbursements totaling US$ 1.1 billion which includes infrastructure projects and undisbursed loans signed in 2015. Loans contracted in 2015 are semi-concessional (positive grant element below 35 percent). - IDA non-concessional borrowing policy (NCBP): Maldives receives IDA grants and is subject to NCBP; breach of NCBP would entail requesting a waiver. DSA outcomes affect eligibility requirements for future financing from multilateral institutions including IDA and ADB. - Sovereign guarantees: Guarantee scheme not yet approved; staff did not include potential guarantees in the DSA. - Non-debt creating financial flows: Maldives banks have paid down debt and increased assets abroad; these outflows are expected to continue. ### Change in macro assumptions (selected comparatives shown as "Previous" vs "Current") - GDP Deflator: Previous 3.0; Current 2.3; Previous (2021–2034) 3.5; Current (2021–2034) 3.2 - Non interest current account deficit: Previous 4.3; Current 9.7; Previous (2021–2034) 4.1; Current (2021–2034) 7.5 - Primary deficit: Previous 3.6; Current 9.7; Previous (2021–2034) 2.4; Current (2021–2034) 4.7 - Real GDP growth (in percent): Previous 4.6; Current 4.3; Previous (2021–2034) 4.5; Current (2021–2034) 4.4 - Growth of exports of G&S (in percent): Previous 8.5; Current 5.4; Previous (2021–2034) 7.9; Current (2021–2034) 7.5 - Growth of imports of G&S (in percent): Previous 8.1; Current 6.1; Previous (2021–2034) 8.2; Current (2021–2034) 7.4 *Source: IMF staff report and Appendix II, Maldives — Staff Report for the 2016 Article IV Consultation (Appendix II: ADB Updated Interim Country Partnership Strategy Results Framework), April 8, 2016.* ### Box 2. Scaling up and new borrowing ### Box 2. Scaling up and new borrowing ### Planned infrastructure and financing - Planned scale up in the 2016 Budget is unprecedented for Maldives and includes: - Ibrahim Nasir International Airport development (cost estimate: US$828 million) - Road bridge connecting the airport to the capital (cost estimate: US$189 million) - Continued investment in new housing developments and relocation and expansion of the port - Loan agreements and commitments signed/received: - US$ 373 million with China’s Exim Bank (runway and fuel farm) and commitments for other airport costs - Implementation agreement with China’s Exim Bank for the road bridge project - Three other external loans signed in 2015: US$ 80 million with Saudi Funds (housing development), US$ 6 million with Abu Dhabi (waste management), and US$ 50 million with OPEC Fund (water and sewerage project) - Terms and assumptions: - Loans are semi-concessional with low interest rates (2 to 5 percent) and longer maturities (close to 20 years or more) and grant elements close to 30 percent - Authorities expected to continue negotiating similar terms; this assumption is used for future disbursements in the DSA - Total external disbursements are estimated to be US$ 1.1 billion (including the undisbursed loans signed in 2015) and are front loaded until 2019 to meet project timelines ### Staff’s illustrative scenario (measures to stabilize debt and improve fiscal position) - Capital projects - Greater prioritization saving around 2.5 pps of GDP compared to the baseline - Revenue raising - Charge user fees for key infrastructure including a bridge toll (commercial and leisure) - Increase in airport departure tax - Broaden the base of business profits tax and increase rates on some taxes (noting business profits tax rate is low compared to the Asia Pacific region and the tourism goods and services tax is not out of line with competitors) - Expenditure saving - Focus on public sector wage bill; restart public service review while preserving key functions - Baseline costs review of healthcare to identify pressures and scope for savings - Better targeting of social welfare and food subsidies through means testing; eliminate electricity subsidy (currently delayed) - Strengthen SOE transparency and oversight - Achieve savings through greater use of renewable energy and other measures - Public financial management - Strengthen public financial management, develop a debt strategy and a public investment framework - Growth dividend - Improving efficiency of public investment and stabilizing debt could generate longer term growth dividends - In the medium term, growth could be around 0.5 pps per year higher than in the baseline, falling back to 0.3pps by 2030–2034 ### External and public debt sustainability (key statistics and risks) - External debt sustainability - Main concern is PV of debt-to-GDP ratio driven by capital spending - Under the baseline: - Nominal PPG external debt rises to 56.9 percent of GDP in 2035 - PV of PPG external debt to GDP is just under the threshold around 2020, necessitating further analysis under the probability approach - Under the probability approach the threshold for the PV of external PPG debt-to-GDP ratio is breached in the baseline - External debt path is vulnerable to standard DSA shocks and especially to a one time depreciation shock and an exports shock - Staff view: debt distress in Maldives has deteriorated from a moderate to a high risk of debt distress - Public debt sustainability - PV of public debt rises from 66.6 percent of GDP in 2014 to 161.1 percent of GDP in 2035 under the baseline - Domestic debt is highly vulnerable to shocks to the primary balance, to growth and to data in line with historical averages ### Assessment and policy recommendations - Without fiscal adjustment and careful management of the infrastructure program: - Current policies would lead to large domestic and external financing requirements - High financing needs are unlikely to be met on a sustained basis and could magnify as infrastructure loan repayments come due in the medium term - Potential outcomes include financing problems, the need for abrupt fiscal consolidation and pressure on the exchange rate - Recommended policy actions: - Additional fiscal consolidation measures in the near term - Greater prioritization of overall capital expenditures - Improved public financial management - Tighter expenditure control and public financial management reforms to stabilize the debt ratio and place it on a downward path - Even with sustained fiscal consolidation, Maldives would remain vulnerable for a number of years to: - Deterioration of public finances - External shocks to tourism earnings and foreign direct investment - Loss of confidence amid rising fiscal pressure *Box 2. Scaling up and new borrowing — IMF staff analysis (from the provided content).* ### CONCLUSION ### CONCLUSION ### Risk rating and overall assessment - Maldives’ debt distress has deteriorated and it currently faces a high risk of external debt distress. - The assessment of the overall risk of debt distress is also high risk and is reinforced by significant vulnerabilities related to domestic debt. ### Staff’s illustrative scenario and policy recommendations - To lower the risks staff suggest policy measures described in the staff’s illustrative scenario above. - A more careful scale up of overall capital expenditure together with offsetting fiscal measures can: - help boost the growth impact of infrastructure spending (this is also supported by an alternative model looking at public investment debt and growth dynamics), - and would help limit the rise in both public and external debt. ### Authorities’ views - The authorities view the substantial increase in external borrowing as needed to finance infrastructure investment to: - ensure that Maldives remains an attractive tourism destination, - and to address climate change challenges. - The authorities are seeking long term loans on the best terms available. - They are mindful of the risks and are seeking to contain current expenditures while undertaking the scale up. - Over the longer run, the authorities believe that the infrastructure investment will add substantially more to growth than suggested by staff and that the payoffs should be sufficient to enable debt reduction. - They concur with staff that the Paris COP21 agreement opens up new opportunities to finance climate change adaptation on concessional terms and plan a strategic approach to such investments going forward. - They noted the change in the external risk rating from moderate to high risk of debt distress and disagreed with the change, given the conservative assumption of growth used by the IMF. - They expect that the infrastructure scale up would enable a shift in the production frontier to a higher growth path. ### Indicative debt dynamics and stress-test outcomes (selected highlights from staff analysis) - Debt metrics and stress tests are presented in Figures 1–5 and Tables 1–4 in the source. - Table 1 (External Debt Sustainability Framework, Baseline Scenario, 2010–35) key figures: - External debt (nominal) series includes: 46.1, 43.5, 35.2, 31.8, 33.4, 31.3, 35.7, 45.4, 50.5, 59.3, 60.2, 58.1, 56.9 (percent of GDP across historical years and projections as provided). - Of which: public and publicly guaranteed (PPG) series includes: 27.8, 30.4, 29.4, 27.3, 22.9, 22.1, 27.4, 36.8, 45.4, 48.6, 48.6, 41.9, 34.8 (percent of GDP). - Change in external debt: -3.2, -2.6, -8.2, -3.5, 1.6, -2.0, 4.4, 9.7, 9.5, 4.3, 0.9, -0.9, 0.2 (percent of GDP). - PV of external debt (selected entries): 28.3, 26.4, 29.8, 37.2, 44.5, 48.1, 49.6, 50.6, 50.6 (percent of GDP as reported). - PV of PPG external debt (selected entries): 17.8, 17.2, 21.5, 28.5, 34.9, 37.4, 38.0, 34.4, 28.4 (percent of GDP). - PV of PPG external debt in percent of government revenues (selected entry): 56.2, 49.0, 61.1, 83.8, 106.4, 116.2, 118.3, 108.1, 89.1. - Debt service-to-exports ratio (in percent) (selected series): 10.7, 8.8, 8.4, 6.9, 6.0, 7.7, 7.1, 7.0, 6.8, 7.0, 6.9, 9.0, 10.3. - Total gross financing need (Millions of U.S. dollars) (selected entries): 353.0, 319.0, 267.1, 10.9, -17.8, 236.0, 226.7, 422.7, 537.6, 449.7, 358.9, 749.6, 1836.0. - Non-interest current account deficit that stabilizes debt ratio (selected entries): 9.8, 18.2, 14.7, 7.1, 1.6, 8.9, 2.3, 3.8, 6.3, 8.1, 8.2, 8.9, 5.7. - Key macroeconomic assumptions from Table 1 (selected figures): - Real GDP growth (in percent) series includes: 7.2, 8.7, 2.5, 4.7, 6.5, 5.3, 5.7, 1.9, 3.5, 3.9, 4.6, 4.7, 4.8, 3.9, 4.4, 4.5, 4.4 (as reported across historical and projection periods). - Effective interest rate (percent) series includes: 3.4, 2.9, 2.3, 2.0, 2.9, 2.7, 0.5, 3.6, 3.3, 3.5, 3.4, 3.2, 3.2, 3.4, 3.7, 4.4, 4.0. - Grant element of new public sector borrowing (in percent) (selected entries): 20.8, 19.8, 23.5, 24.7, 24.5, 17.1, 21.7, 15.9, 15.1, 15.6 (as reported). - Sensitivity analysis (Table 2) shows vulnerability of PV of debt ratios to alternative scenarios and bound tests: - PV of debt-to-GDP ratio (selected projection years): Baseline: 17, 21, 29, 35, 37, 38, 34, 28 (years 2015, 2016, 2017, 2018, 2019, 2020, 2025, 2035 as presented). - Illustrative stress B6 (one-time 30 percent nominal depreciation relative to the baseline in 2016) leads to larger increases in PV and debt service indicators across tables and figures (see Table 2 entries). - Public sector debt metrics (Table 3, baseline scenario): - Public sector debt (percent of GDP) (selected projections): 63.9, 64.8, 66.6, 73.1, 83.1, 96.5, 109.0, 117.5, 120.8, 133.9, 161.1 (selected years and averages as reported). - PV of public sector debt (selected projection entries): 61.5, 68.1, 77.1, 88.2, 98.5, 106.4, 110.2, 126.4, 154.8. - Gross financing need (selected entries): 39.9, 41.7, 45.9, 52.9, 63.8, 72.1, 76.3, 76.5, 76.0, 95.5, 131.3. - PV of public sector debt-to-revenue and grants ratio (in percent) (selected entries): 191.6, 189.9, 217.0, 256.4, 297.5, 327.2, 340.6, 395.0, 483.8. - Staff’s illustrative scenario charts (Figures 4–5) depict baseline, historical scenario, and most extreme shock paths for: - Debt Accumulation; PV of debt-to-GDP ratio; PV of debt-to-exports ratio; PV of debt-to-revenue ratio; Debt service-to-exports ratio; Debt service-to-revenue ratio; and public debt indicators under alternative scenarios including a “Fix Primary Balance” case. *Source: STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION—SUPPLEMENTARY INFORMATION (CONCLUSION).* ### 1. This supplement reports on information that has become available since the Staff Report ### This supplement reports on information that has become available since the Staff Report ### Recent data and short-term outlook - Published data for 2015 are slightly softer than staff’s projections but latest monthly indicators point to a pick up in activity in 2016. - GDP: - Preliminary estimate for GDP growth in 2015: 1.5 percent (staff projection: 1.9 percent). - Tourism arrivals picked up by 4.3 percent in January-March 2016 compared to the same period last year; higher arrivals from Europe offset a continued decline in arrivals from Asia. - Inflation: - Inflation rose by 1.4 percent year on year in March; continues to benefit from pass through of lower oil prices and declining communications costs. - Current account and reserves: - 2015 current account deficit: 8.8 percent of GDP (staff projection: 8 percent of GDP). - Gross reserves: $685 million in early May (2.9 months of import cover). - Usable reserves: $225 million in early May (1 months of import cover). - Parallel market premium: hovering between 6 and 7 percent. - Fiscal position: - Staff assesses 2015 overall deficit at 8.4 percent of GDP (broadly in line with projections). - Outturn: slightly weaker revenues offset by modestly lower current spending. - Estimates are preliminary; expenditures and grants will be verified ahead of November’s Budget. ### External sector, tourism, and foreign financing - Tourism remains the dominant external sector driver; growth outperformed peers in recent years except in 2015 when market expansion from China, Russia, and Ukraine slowed. - Foreign direct investment averaged over 10 percent of GDP in recent years, helping sustain reserves, limit pressure on the exchange rate peg, and contain external debt. - Authorities expect: - Continued market expansion for tourism aided by new hotels under construction and extension of airport capacities. - Low price elasticity of demand could allow strong tourism growth despite dollar appreciation. - Anticipate growth to return to 6 percent levels (authorities’ expectation). ### Fiscal policy, 2016 budget, and megaprojects - 2016 budget targets a narrowing of the fiscal deficit by 1¾ percent to 6.7 percent of GDP after accounting for a 240 percent increase in capital expenditure to nearly 20 percent of GDP in 2016. - Financing of the 2016 capital spike: higher tax and non tax revenues as well as grants; authorities may delay projects if revenues or expected non tax revenue from resort leases or grants do not materialize. - Authorities’ planned fiscal measures under consideration: - A bridge toll or a higher airport departure tax. - Broadening the base of the business profits tax. - Expenditure savings through better targeting of subsidies, improved oversight of SOE finances, and potential for greater use of renewable energy. - Megaprojects: - Planned spending on three megaprojects is estimated to amount to 30 percent of GDP over the next three years. - Project 1: Expansion of the airport (currently near full capacity) to sustain tourism growth. - Project 2: Population resettlement to a large island near the capital and an airport to reduce service delivery costs, help adapt to climate change, and improve job opportunities. - Project 3: Relocate and expand port facilities to ease bottlenecks and improve resilience to climate change. - These projects will be mostly foreign-financed, at reasonable market cost, and subject to detailed feasibility studies. ### Debt sustainability and authorities’ perspective - Staff’s DSA concerns noted by authorities; authorities believe staff’s assessment that the investment upscale will only add ½ percent to GDP growth underestimates growth prospects. - Authorities’ arguments: - Expect tourism recovery and expansion of Asian markets to drive growth; many new hotels and airport capacity increases will support this. - Consider staff’s assumption of public investment efficiency (aligned with average of less developed countries) too conservative given Maldives’ more efficient tax system. - Fund TA is supporting public financial management and capital budget strengthening; IMF TA planned in June for a public investment management assessment. - Authorities have a track record of implementing staff recommendations, particularly tax reforms; they would consider broadening the tax base and deferring expenditures if revenues disappoint. - Authorities request that the Fund review the DSA framework to account for special circumstances of small states that rely on large borrowing to harness gains from investment scale-up. - Authorities contest the DSA assessment that Maldives currently faces high risk of external debt distress, attributing this in part to conservative growth projections. ### Exchange rate regime and monetary policy - Authorities are committed to a stabilized exchange rate regime within the currency band; agree fiscal improvement is the best support for it. - Since the 2011 devaluation, the real exchange rate has appreciated by 30 percent. - The capital account is very open; the economy is highly dollarized. - Parallel market operation is structural due to dollar-denominated tourist transactions; premium is relatively stable. - MMA monetary policy actions: - Eased policy by significantly reducing the marginal reserve requirement in 2015 to reduce borrowing cost, boost private credit, and lengthen sovereign bond maturities. - Overall expansion in monetary aggregates remained contained in 2015 due to lower net foreign assets and sluggish private sector credit growth in the first half of the year. - Credit picked up in the second half of 2015 after a long period of stagnation. - Financial inclusion and supervisory measures: - Enhancing financial inclusion is a national priority; movement toward mobile banking via Dhoni Banking Units to reach outer islands. - Announced sovereign guarantee scheme for private sector loans in tourism to revive stalled projects; authorities plan to limit its size and contingent cost. - MMA continues to reinforce supervisory capacity within a risk-based approach. ### Climate change, adaptation planning, and investment coordination - Maldives was one of the fifteen countries first to ratify the Paris Agreement on April 22. - Authorities shared a national development plan for climate adaptation with staff. - Authorities agree with staff that a more strategic approach is needed: - Set current infrastructure plans in context with systematic climate adaptation planning. - Include reporting on the budgetary impact of adaptation policies. - Quantify and present climate adaptation policies in each budget to aid access to financing. - Seek examples of how others have integrated such measures. - Improve coordinated planning and monitoring of different investment projects. ### Special economic zones and tax/incentive concerns - Development of special economic zones could help diversify activity into labor-intensive sectors. - Authorities note staff concerns on excessive tax incentives and potential for tax erosion or tax evasion. - Mitigating measures: adequate reporting procedures and consideration of safeguards when viable projects are under consideration. *Prepared by Asia and Pacific Department; May 10, 2016. Statement by Mr. Hazem Beblawi and Ms. Wafa Fahmi Abdelati; May 13, 2016.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16135.pdf_