Press Release No. 21/73

IMF Staff Completes 2021 Article IV Mission with the Republic of the Marshall Islands

March 22, 2021

• The Marshall Islands took swift and strong measures to contain the Covid-19 pandemic with no record of local transmission and is currently leading the Pacific’s Covid-19 vaccine rollout.
• The containment measures nevertheless have strained the economy. GDP is expected to have contracted 3.3 percent in FY2020 and further decline 1.5 percent in FY2021.
• Post-pandemic, a fiscal consolidation is needed to build buffers to mitigate risks of a fiscal cliff and protect long-term income.

Washington, DC: Ms. Yong Sarah Zhou led a virtual Article IV consultation with the Republic of the Marshall Islands (RMI) from March 1 to 18. At the conclusion of the visit, Ms. Zhou issued the following statement:

“The Marshall Islands’ economy experienced strong growth before the pandemic. Real GDP is estimated to have increased by around 6.5 percent in FY2019 (October 1-September 30), driven by strong fishery and construction activities. Inflation remained low, given weak commodity prices.

“As a result of strong and swift containment measures, RMI has thus far remained one of the few countries with no record of local transmission of COVID-19. The government has put in place a vaccination plan, supported by the U.S. RMI is leading the Covid-19 vaccine rollout in the Pacific Islands, with the first round of vaccination of over 30 percent of the total population already completed.

“However, the economic impact of COVID-19 has been severe, as elsewhere. Real GDP is expected to have contracted by 3.3 percent in FY2020 and is forecast to decline by around 1.5 percent in FY2021, due to the pandemic-related disruptions to production, sales, and employment, especially in the fishery, transportation, and tourism sectors. The economy is expected to rebound in FY2022, based on the assumption that health restrictions on economic activity will ease gradually. Inflation is projected to rise slightly, reflecting higher fuel prices.

“Uncertainty around the economic outlook is exceptionally high, given the pandemic, and risks are tilted to the downside. An extended border closure due to a more protracted Covid-19 pandemic worldwide could prolong weak economic activity. The issuance of the digital currency SOV as a second legal tender would raise risks to macroeconomic and financial stability as well as financial integrity. The issuance of the SOV could jeopardize the RMI’s last USD corresponding banking relationship (CBR). This combined with anti-money laundering and combatting the financing of terrorism (AML/CFT) risks (including those related to the SOV) could disrupt external aid and other important financial flows, resulting in a significant drag on the economy. Climate change and related natural disasters are other downside risks.

“RMI also faces important fiscal risks. Without enough fiscal consolidation, the country will face increased fiscal risks of a fiscal cliff if the Compact of Free Association (COFA) between RMI and the United States expires in FY 2023. Alternatively, the potential renewal of the COFA on favorable terms presents upside risks.

“Against this background, the team’s policy recommendations focus on three main objectives areas: (i) ensuring a durable economic recovery after the downturn and long-term fiscal self-reliance; (ii) maintaining financial stability; and (iii) achieving green, sustainable, and inclusive growth after the pandemic.

“The team commends the government’s swift measures to secure health preparedness and mitigate the economic impact of the pandemic, building on the support by donors. The team recommends keeping the response package in place until the recovery is firmly underway while reprioritizing and reallocating the spending as needed, given the uncertainty about COVID-19 developments in the global economy.

“Post-pandemic, a gradual fiscal consolidation is necessary to prepare the possible expiration of the U.S. grants and reduce risks of a fiscal cliff. Even if the COFA is renewed, some adjustment will likely still be needed to maintain sound public finances and reduce the dependency on external grants. An important element of sound public finances would be the preservation of the value of the Compact Trust Fund adjusted for inflation. The team recommends a combination of spending and revenue measures to achieve the consolidation. It would be important for the government to enact the tax reform bill that has already been prepared and to reform the taxation of offshore shipping and corporate registries. The recent preparation of the Fiscal Responsibility and Debt Management Act is welcome, but timely enaction and effective implementation will be critical for success.

“Staff welcome the authorities’ continued cautious approach towards the digital currency Sovereign (SOV). The SOV would pose significant risks to macroeconomic and financial stability and financial integrity. The RMI’s legal, regulatory, and institutional framework is not yet ready to accommodate the SOV issuance and manage associated risks. The team’s assessment, therefore, remains that the potential cost of the SOV issuance will likely outweigh the expected benefits.

“Another concern are financial integrity risks in the non-resident and shipping (offshore) sectors. Progress has been made to strengthen the RMI’s AML/CFT regime in line with recommendations made by the Asia Pacific Group on Money Laundering but weaknesses in the legal framework and capacity constraints among regulatory authorities might not allow for the AML/CFT regime to effectively mitigate financial integrity risks. In particular, timely access to accurate beneficial ownership information on entities registered with the RMI is not ensured. Further, there is a lack of meaningful oversight of the offshore sectors – including relating to the Trust Company of Marshall Islands (TCMI), which has been delegated the task of operating the non-resident and shipping registries – and insufficient AML/CFT regulation of offshore activities. The foregoing may contribute to pressures on correspondent banking relationships (CBRs). Staff recommend that the Government of Marshall Islands strengthen the AML/CFT legal/regulatory framework and the capacity of its agencies to ensure proper AML/CFT regulation of offshore sectors, oversight of delegated public functions and effective mitigation of financial integrity risks.

“A green and sustainable recovery requires accelerating the preparation of a national adaptation plan (NAP) to climate change. The team welcomes the government’s commitment to finalize the NAP in 2021 and offers support on PFM reforms to enhance RMI’s ability to access global climate funds.

“IMF Staff recommend stepping up implementation of SOE reforms. In the medium to long term, the government should develop direct and targeted fiscal transfers, which are more efficient in redistributing income to the poor than paying subsidies to SOEs for social services while reducing economic distortions.

“Staff recognize the difficult, long-standing structural challenges around economic diversification and growth for a small and remote economy like the RMI. Improving the business environment could play an important role in enabling the private sector to grow and become more dynamic. Land registration reforms would be critical step for the promotion of business investment in the RMI. Improving education and opportunities for training and skills development and broaden social services could help in lowering migration to the U.S. and enabling higher local growth.

“The IMF team is grateful to the government of the RMI as well as private sector representatives for the constructive and candid discussions.”