IMF Staff Completes 2021 Article IV Mission to the Federated States of Micronesia

August 3, 2021

End-of-Mission press releases include statements of IMF staff teams that convey preliminary findings after a visit to a country. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF's Executive Board for discussion and decision.
  • The Federated States of Micronesia (FSM) has been successful in preventing the spread of COVID-19 to date and the economic policy response has helped mitigate the negative impact on the economy.
  • The near-term growth outlook has significantly deteriorated, and supportive policies should therefore continue, prioritizing measures to protect the vulnerable and underpin the recovery.
  • To rebuild longer-term fiscal resilience, a gradual fiscal consolidation is warranted. Accelerating structural reforms would be key to develop a dynamic private sector, diversify the sources of growth, and adapt to climate change.

Washington, DC: An International Monetary Fund (IMF) team led by Piyaporn Sodsriwiboon held virtual Article IV consultation with the FSM authorities and private sector representatives during July 19-30, 2021. At the end of the mission, Ms. Sodsriwiboon issued the following statement:

“The Federated States of Micronesia (FSM) has been successful in preventing the spread of COVID-19 thus far. Public health measures have been effective, and the economic policy response has been strong and broadly appropriate, helping mitigate the negative impact of the pandemic on the economy.

“Notwithstanding all these efforts, the near-term growth outlook has significantly deteriorated. The economic contraction is likely to deepen in FY2021 with growth falling to -3.2 percent in FY2021. A slow recovery is projected for FY2022 driven by a gradual border reopening. Once the pandemic fades, real GDP is expected to return to the pre-COVID level in FY2023, albeit output will remain on a lower trajectory through the medium term reflecting some permanent scarring. Inflation is expected to rise in FY2021 due to higher imported prices including for commodities. Fiscal and external balances are projected to remain in surplus in FY2021.

“Uncertainty surrounding the outlook remains high, and risks are tilted to the downside. A longer border closure due to the pandemic or a possible domestic outbreak could prolong subpar economic growth and put stress on the fragile domestic health system. Uncertainty related to the expiration of financial and services support under the Compact Agreement with the United States could undermine investor confidence and weigh significantly on the medium-term economic prospects, particularly the FSM’s capacity to cope with a possible fiscal cliff post-FY2023. Given the country’s geographic dispersion and isolation, climate change-induced natural disasters remain a key downside risk to the economy. On the upside, a renewal of financial and services support provisions under the Compact Agreement would boost confidence. Prompt implementation of fiscal and structural reforms could lift potential growth and ensure budget self-sufficiency and fiscal sustainability.

“Looking ahead, economic policies should focus on supporting the recovery and rebuilding fiscal resilience to cope with the possible fiscal cliff in FY2024. Near-term policies should prioritize measures to protect the vulnerable, accelerate the vaccination process, and underpin the economic recovery. To ensure fiscal resilience, a comprehensive medium-term fiscal policy approach that addresses the possible fiscal cliff and safeguards debt sustainability is needed. Accelerating structural reforms would be key to develop a dynamic private sector, diversify the sources of growth, and adapt to climate change.

“Supportive fiscal measures should remain in place until the recovery is firmly underway. This could be achieved by the extension of fiscal support provided to the unemployed, low-income households, and informal workers. The vaccination process should be accelerated to achieve collective immunity as early as possible to safeguard the public health and enable a gradual reopening of the economy. Efforts to execute existing commitments on public infrastructure investment should also be increased to help reactivate economic activity and strengthen the recovery as soon as the borders are reopened.

“Once the recovery is firm, a gradual fiscal consolidation is warranted to reduce fiscal risks related to the possible expiration of the Compact Agreement and rebuild longer-term fiscal resilience. A gradual fiscal adjustment of about 1-2 percent of GDP per year could be implemented over five years when growth is expected to strongly bounce back and stay above trend. The adjustment could be achieved through domestic revenue mobilization and expenditure rationalization. In this regard, the establishment of the National Tax Reform Commission to strengthen the tax system, expand the revenue base, and ensure equitable revenue sharing is welcome, and tax reforms should prioritize the introduction of a value-added tax (VAT). State support programs and purchases of goods and services could be streamlined and rationalized, while protecting social spending and public infrastructure investment. Efforts to strengthen public financial management (PFM) and public investment management (PIM) should also be enhanced. Even if the Compact grants are renewed, some of the recommended adjustments would be beneficial to make the tax system and government spending more efficient.

“The FSM’s financial sector has so far remained resilient. Until the recovery is underway, the near-term financial sector support such as the interest payment relief and debt moratorium could be extended for viable firms. Close monitoring of non-performing loans and broader credit quality indicators such as restructured and doubtful loans is warranted as the COVID-19 crisis is still evolving. More needs to be done to facilitate financial development, including updating banking laws, adopting prudential standards for banks, and speeding up structural reforms to ease the bottlenecks to credit supply and demand.

“Tackling structural challenges to support private sector growth remains critical to set the stage for a robust recovery and pursue sustainable and inclusive growth. Reforms to help reduce business startup costs and time for settling disputes, lowering the regulatory burden on foreign direct investment (FDI), improving the efficiency of the judicial process, enhancing coordination across states, and establishing a national single window system for trade and FDI should be prioritized. ICT infrastructure investment should be expediated to enhance digital connectivity, helping overcome the geographical remoteness and expand economic opportunities.

“Improving climate resilience would help support the recovery, boost the long-term growth potential, and mitigate climate disaster risks. There is a need to swiftly develop an overarching National Adaptation Plan and disaster resilience strategy. Improving access to climate finance should be supported by stronger public investment implementation capacity. The recent amendment of the FSM Trust Fund law, which mandates the fund to invest in clean and green portfolio, is welcome and sends a strong signal of the FSM’s call for green and low-carbon development.”

The team met with Finance Secretary Amor, Environment, Climate Change, and Emergency Management Secretary Yatilman, Transportation, Communication, and Infrastructure Secretary Apis, senior officials of the national government and state-owned enterprises, the financial sector community, development partners and private sector representatives. The team would like to thank the Micronesian authorities for the constructive discussions and close cooperation.

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