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

IMF News, August 3, 2021

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The IMF team held a virtual Article IV consultation with FSM authorities and private sector representatives during July 19-30, 2021.
The FSM has been successful in preventing the spread of COVID-19 to date; public health measures and the economic policy response have been "strong and broadly appropriate," helping mitigate the pandemic's economic impact.
Near-term growth outlook has "significantly deteriorated."
Growth projections and key macro outcomes:
- Growth falling to -3.2 percent in FY2021.
- A slow recovery is projected for FY2022 driven by a gradual border reopening.
- Real GDP is expected to return to the pre-COVID level in FY2023, albeit with output remaining 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 remains high and risks are tilted to the downside.

Downside risks:
- A longer border closure or a possible domestic outbreak could prolong subpar growth and strain the domestic health system.
- Uncertainty around the expiration of financial and services support under the Compact Agreement with the United States could undermine investor confidence and weigh on medium-term prospects, particularly the FSM’s capacity to cope with a possible fiscal cliff post-FY2023.
- Climate change-induced natural disasters remain a key downside risk given geographic dispersion and isolation.
Upside scenarios:
- 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.

Maintain supportive fiscal measures until the recovery is firmly underway, prioritizing protection of the vulnerable and underpinning the recovery:
- Extend fiscal support provided to the unemployed, low-income households, and informal workers.
- Accelerate the vaccination process to achieve collective immunity as early as possible to safeguard public health and enable gradual reopening.
- Increase efforts to execute existing commitments on public infrastructure investment to reactivate economic activity when borders reopen.
Financial sector near-term support:
- Extend measures such as interest payment relief and debt moratorium for viable firms until the recovery is underway.
- Closely monitor non-performing loans and broader credit quality indicators such as restructured and doubtful loans.

A comprehensive medium-term fiscal policy approach is needed to address the possible fiscal cliff and safeguard debt sustainability.
Once the recovery is firm, implement a gradual fiscal consolidation to 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.
- Adjustment should be achieved through domestic revenue mobilization and expenditure rationalization.
Institutional and tax measures:
- The establishment of the National Tax Reform Commission to strengthen the tax system, expand the revenue base, and ensure equitable revenue sharing is welcome.
- 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.
- Strengthen public financial management (PFM) and public investment management (PIM).

Key structural reforms recommended to support private sector development and diversify growth:
- Reduce business startup costs and time for settling disputes.
- Lower the regulatory burden on foreign direct investment (FDI).
- Improve the efficiency of the judicial process.
- Enhance coordination across states.
- Establish a national single window system for trade and FDI.
- Expedite ICT infrastructure investment to enhance digital connectivity, overcome geographical remoteness, and expand economic opportunities.
Climate resilience and green development:
- Swiftly develop an overarching National Adaptation Plan and disaster resilience strategy.
- Improve access to climate finance supported by stronger public investment implementation capacity.
- Note: the recent amendment of the FSM Trust Fund law mandates the fund to invest in a clean and green portfolio.

The financial sector has so far remained resilient.
To facilitate longer-term financial development:
- Update banking laws.
- Adopt prudential standards for banks.
- Speed up structural reforms to ease bottlenecks to credit supply and demand.

The IMF 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 thanked the Micronesian authorities for constructive discussions and close cooperation.

Source: IMF Staff Completes 2021 Article IV Mission to the Federated States of Micronesia — Press Release No. 21/242 (August 3, 2021).