Press Release No. 17/350

IMF Executive Board Concludes 2017 Article IV Consultation with the Federated States of Micronesia

September 15, 2017

On September 1, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation^[1] with the Federated States of Micronesia (FSM).

FSM is a small and sparsely-populated state vulnerable to climate change. Over the medium term, the country needs to prepare for the expiration of grants under the Compact of Free Association with the U.S. from fiscal year 2024 onward, adapt to climate change, and promote sustainable private-sector growth and financial inclusion.

The Micronesian economy continued its gradual recovery in fiscal year 2016 (ending September 30), after three years of contraction during 2012–14. Real GDP is estimated to have grown by 3.0 percent in 2016 (after 3.7 percent in 2015), driven by increased construction activity related to infrastructure projects. Consumer prices remained broadly stable. The fiscal balance recorded an estimated surplus of 9 percent of GDP, after another year of strong revenues from fishing license fees. In 2017, growth is expected to moderate to 2 percent, as the recovery continues at a slower pace.

Despite the recovery, risks are tilted to the downside beyond the near term. Possible extreme weather events resulting from climate change, delays in infrastructure projects, and declining external grants could pose risks to growth. The current trajectory of the Compact Trust Fund is not on track to offset expiring U.S. grants after 2023. The FSM Trust Fund can only partially offset the shortfall. Without fiscal reforms, the fiscal surplus is therefore expected to turn into a deficit beyond 2023. Uncertainties surrounding the global economy could pose risks to trust fund returns and underscores the importance of strengthening fiscal buffers. On the upside, a decisive push for structural reforms could boost potential growth.

Executive Board Assessment[2]

Executive Directors welcomed the recent improvements in economic activity and the strengthened fiscal and external balances, but noted that Micronesia continues to face significant challenges arising from the scheduled expiration of U.S. Compact grants, vulnerability to natural disasters and climate change, and limited private sector activity. Against this backdrop, Directors underscored the importance of implementing sound fiscal policies and structural reforms to ensure long‑term fiscal sustainability, reduce vulnerabilities to external shocks, and promote sustainable, private sector‑led growth.

Directors stressed that gradual fiscal consolidation over the medium term is key to build adequate buffers and preserve fiscal sustainability in light of the scheduled decline in U.S. Compact grants and given vulnerabilities. They urged the authorities to work toward achieving the consensus needed to implement the adjustment efforts envisioned in the 2023 Action Plan. In particular, Directors recommended steps to enhance tax administration, contain current spending while avoiding delays in infrastructure investment, and further increasing budget contributions to trust funds. Accelerating the pace of public financial management reforms will also be critical to support the implementation of the fiscal adjustment and to address weaknesses in budget planning and execution.

Directors called for continued efforts to build resilience to natural disasters and climate change risks, including through explicit budget provisions for adaptation costs. They also encouraged the authorities to develop contingent financing plans for natural disasters from diverse sources.

Directors recommended reducing transportation costs, strengthening regulatory frameworks, and improving access to finance to facilitate private sector development. In this regard, they highlighted that efforts to streamline the investment application process would help attract foreign direct investment.

Directors emphasized the need to promote safe financial inclusion and ensure that the financial system plays its role in supporting growth. They recommended extending the oversight authority of the Banking Board to credit unions. Directors also supported efforts to facilitate more secured lending through developing the long‑term lease market and the online secured transactions registry, while continuing to raise financial literacy and addressing skill gaps.

Directors welcomed the authorities’ commitment to data transparency and the recent implementation of the enhanced General Data Dissemination System. They encouraged further improvements in the compilation of national accounts and external sector statistics to support economic analysis and policymaking.