Journal Issue

Republic of the Marshall Islands

International Monetary Fund
Published Date:
June 2008
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I. Compact Trust Fund and Long-Term Fiscal Sustainability1

1. The Compact Trust Fund (CTF) is the cornerstone of the Marshall Islands’ future. The Republic of Marshall Islands (RMI) is highly dependent on foreign grants, primarily those that are provided under the Compact of Free Association Agreement with the United States.2 The Compact agreement stipulates that grants will steadily decline, and will be eliminated after 2023. After that, the CTF will be the main financial asset of the RMI, and the CTF income will be the key source of revenue for the RMI budget. It is therefore important to know whether the CTF proceeds after 2023 will be sufficient to replace the Compact grants.

2. This chapter analyzes several different scenarios, to assess the likelihood of the RMI achieving budgetary self-sufficiency by 2023. Section A provides the background information on the CTF, and describes its performance to date. Section B presents the baseline scenario, which shows that the CTF is not likely to be sufficient to replace Compact grants after 2023. Section C then analyzes various options that could help increase the CTF balance, and thereby to strengthen the RMI’s fiscal position. The options include seeking additional financial support from the donors, securitizing future U.S. contributions to the CTF, pursuing a more aggressive investment strategy, and running budget surpluses to put additional reserves into the CTF. The analysis shows that options that do not involve decisive policy action can somewhat improve the situation, but will not resolve it. The chapter concludes that fiscal consolidation is a difficult, but necessary step to achieve budgetary self-sufficiency by 2023.

A. Compact Trust Fund: Background

3. The CTF was established in 2004, as part of the amended Compact of Free Association Agreement with the United States (Box I.1). The CTF is incorporated in the District of Columbia as a nonprofit corporation and is governed by the CTF committee, with the United States holding the majority of votes.3 The committee’s responsibilities includeoverseeing the fund’s operation, supervision, management and investment. Thtrust fund committee also appoints a trustee, who has the entire care and custody of all of the assets, and an independent auditor, to audit the fund at appropriate intervals. In addition, the committee has the authority to appoint one or more investment advisers, who may engage in a separate agreement with one or more money managers.4

Box I.1.Marshall Islands: Structure of the Compact Trust Fund

The CTF consists of four interrelated accounts, labeled “A”, “B”, “C”, and “D”.

A Account forms the trust fund “corpus” and contains the RMI’s initial contribution as well as the U.S. contribution and any contribution from other donors. It also consists of income from the fund’s investment up to 6 percent per annum. Any annual investment income that exceeds 6 percent is deposited in the “C” account. At end–2007, the A account slightly exceeded $ 93 million.

B Account will be created in 2022 and used to disburse income after the compact grants come to an end.

C Account was created at the same time as the A account and was designed as a buffer against low or negative annual investment returns. Any annual income on the fund exceeding 6 percent will be deposited in this account.

D Account is an optional account created to hold contributions by the RMI from unanticipated sources, such as revenue surprises and additional grants from donors. The D account must be a separate account and not mixed with the rest of the trust fund; it is not part of the corpus of the trust fund. This account reached $ 3.6 million by end–2007.

4. The purpose of the CTF is to create an income stream to replace (partially or fully) the Compact grants after FY2023, permitting the RMI to achieve budgetary self-sufficiency. According to the Compact agreement with the United States, the Compact grants will decline by $0.5 million per year. At the same time, the United States’ annual contribution to the CTF started with $7million in FY2004, and is scheduled to increase by $0.5 million per year until FY2023, with a partial adjustment for inflation. In FY2024, the Compact grants and the United States’ contributions to the CTF will terminate.

5. The CTF has received contributions from the governments of the RMI, the United States, and Taiwan Province of China. The RMI government has made a contribution of $30 million during FY2004–06. The United States made the scheduled contributions in FY2004–08, in line with the Compact agreement. In FY2005, Taiwan Province of China contributed $5 million to the CTF, and has pledged to further contribute $2.5 million per year until FY2023.

6. The full establishment of the CTF has been delayed. Although a trustee and an investment advisor were appointed early on, an auditor had not been appointed until early 2008. This reflected a disagreement between the trustee and investment advisor over the assignment of custodial rights. As a result the investment advisor could not appoint a money manager, so funds invested in stocks had to be limited to index funds. Furthermore, the Trust Fund committee had not yet provided an annual report, although the RMI government has indicated its willingness to disclose information about the performance of the CTF, including reporting its performance in the annual Budget Statement.

7. At present, the CTF is fully invested in a relatively diversified portfolio. Before 2006, the CTF was invested in a simple money market account. At end–2007, its portfolio consisted of cash equivalents, fixed income securities, and U.S. and international stocks. Almost 80 percent of CTF balance was invested in stocks. In early 2008, the dispute between the trustee and investment advisor over custodial rights was resolved, allowing the investment advisor to pursue a more active investment strategy.

Compact Trust Fund: Asset Allocation, A and D Accounts Combined

(Percent, End-2007)

Source: Goldman Sachs

8. The CTF reached $96.8 million by end–2007. Driven by the surging equity and real estate markets, the returns on the CTF were very strong in FY2006 and FY2007, over 10 percent on average. In the first quarter of FY2008 the returns on the CTF were negative, following the declines in the U.S. and global equity markets. However, available information indicates that the CTF was able to avoid investments in subprime mortgages.

B. 2023: Judgment Day

9. Staff projections show that the CTF can be expected to grow to $680 million by the end of FY2023. These projections assume that the fund receives no new contributions from any donors, beyond what has already been pledged by the United States and Taiwan Province of China. It is also assumed that the annual returns on the CTF average 6 percent in nominal terms between now and FY2023,5 and that the U.S. inflation is equal to 2.4 percent per year on average over that period.6

Compact Trust Fund Projection

(Millions of U.S. Dollars)

Source: RMI government; and Fund staff estimates.

10. The projected balance for end–FY2023 is significantly higher than a similar projection made 3 years ago, when the CTF was being set up. The difference is mainly due to the substantial contributions from Taiwan Province of China, and to a lesser extent to the high returns on the CTF that were achieved in FY2006 and FY2007. This underlines the importance for the RMI of receiving the future pledged contributions from Taiwan Province of China, and of seeking further contributions from other potential donors.

Compact Trust Fund Balance

(Millions of U.S. Dollars)

Source: RMI government; and Fund staff estimates.

Compact Trust Fund: The Baseline Scenario
(In millions of U.S. dollars)
CTF in 2023678.6
Compact grants in 202347.0
CTF earnings available for withdrawal 1/24.5
Annual surplus (+) or shortfall (-) 2/-22.5
Source: Fund staff estimates.

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023.

Source: Fund staff estimates.

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023.

11. However, the CTF balance may not be enough to fully replace Compact grants in FY2024. Given the terms of the Compact agreement (and assuming annual U.S. inflation of 2.4 percent), the annual Compact grants are projected to reach $47 million in FY2023. These grants will then terminate in FY2024, and will need to be replaced from other sources. Assuming the nominal returns on the CTF of 6 percent per annum, the fund’s investment earnings are projected to reach $41 million in FY2024, $6 million short of the amount needed to replace the grants. However, in order to preserve the real value of the fund, the RMI government would not be able to withdraw the full amount of the CTF’s earnings to pay for annual budget expenditures. The maximum amount that can be withdrawn, so that the real value of the CTF is kept constant, can be calculated as

where x is the maximum amount that can be withdrawn, i is the annual nominal rate of return (assumed to be 6 percent), and π is the rate of inflation (assumed to be 2.4 percent). With these assumptions, x is equal to $24.5 million. Therefore, in FY2024 the RMI government would need to either start eroding the real value of the CTF, with the prospect of eventually depleting the fund, or face the budgetary shortfall of $22.5 million (equivalent to about 16 percent of projected budget expenditures in FY2023).

C. What Is To Be Done?

12. This section considers various scenarios that could increase the CTF balance in FY2023, and therefore help the RMI to achieve fiscal sustainability at that time. First, scenarios that do not require any significant policy action from the authorities are considered. Then, the last part of the section looks at the scenario that involves a substantial fiscal consolidation, in order to achieve sustained budget surpluses that can be used to add reserves to the CTF.

Alternatives that do not involve policy action

Additional contributions to the CTF

13. The most straightforward way to boost the CTF would be through increased contributions from donors. This could potentially include larger contributions from the United States or Taiwan Province of China, or persuading new donors to contribute to the fund.

14. However, staff projections show that a very significant additional contribution would be needed to achieve fiscal sustainability after FY2023. For example, if we continue to assume nominal returns of 6 percent on the CTF, an additional $2.5 million contributed every year between FY2010 and FY2023 would increase the CTF balance in FY 2023 by about $56 million.7 The amount available for budget expenditures (keeping the CTF constant in real terms) will then increase by only $2 million, significantly less than the $22.5 million shortfall. In fact, projections show that even an extra $20 million a year would not be sufficient to cover fully the shortfall. To achieve fiscal sustainability through donor support, the CTF will need to receive either an additional $25 million per year for fourteen years from FY2010 to FY2023, or a lump-sum payment of $280 million in FY2010. Both alternatives appear equally unrealistic.

Compact Trust Fund: Alternatives Without Policy Action
CTF in 2023CTF earnings available

for withdrawal 1/
Annual surplus (+) or

shortfall (-) 2/
(In millions of U.S. dollars)
Baseline scenario678.624.5-22.5
I. Additional contributions
to the CTF
$2.5 mln per year from FY2009734.726.4-20.5
$5 mln per year from FY2010790.428.5-18.5
$20 mln per year from FY20101140.342.8-4.2
$280 mln lump-sum in FY20101311.747.20.3
II. Securitization of future
contributions 3/707.825.5-21.5
III. Higher returns on CTF
7 percent per annum754.734.7-12.2
8 percent per annum840.347.10.1
Source: Fund staff estimates.

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 of $47 million.

Securitization scenario is described in the text.

Source: Fund staff estimates.

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 of $47 million.

Securitization scenario is described in the text.

Securitization of future contributions to the CTF

15. Another possible method to augment the CTF is to securitize the future contributions. This method has been used by some international development institutions, and was also suggested in GAO (2007).8 Ketkar and Ratha (2001) also argued that in some circumstances, securitization of future flow receivables can help public and private sector entities in developing countries obtain credit ratings higher than those of their governments and raise funds in international capital markets.

16. However, in the case of Marshall Islands the arguments for securitization appear weak. Staff analyzed a realistic scenario which involves borrowing $100 million in FY2010 at a 4 percent interest rate, collateralized by future U.S. contributions to the CTF. This scenario assumes relatively favorable terms of the loan, with only interest payments made during the first seven years, until FY2014. After that, if the U.S. contributions are fully used to repay interest and principal, the loan would be fully repaid by end–FY2023. However, with a nominal return on the CTF of 6 percent, the amount available for budget financing in FY2024 would increase only by $1 million. At the same time, securitization would introduce a number of additional risks, and would increase volatility of the CTF returns.9 On balance, therefore, it appears that the benefits from securitization would be relatively small, and do not justify the incurring of additional risks.

Higher returns on CTF investments

17. Sufficiently high returns on CTF investments can in principle help achieve fiscal sustainability. In the above projections, a relatively conservative investment strategy for the CTF was assumed, with average annual nominal returns of 6 percent. A more aggressive investment strategy may yield higher returns on average, although it will also increase therisks. Projections show that, if the CTF investments yield average annual nominal returns of 7 percent instead of 6 percent, the budgetary shortfall in FY2024 would be reduced from $22.5 million to $12 million. A further increase of average annual nominal returns to8percent would eliminate the shortfall altogether. In this case, however, fiscal sustainability becomes contingent on being able to maintain the investment returns of at least 8 percent in every year after FY2024, which can be rather difficult.

18. However, given the importance of the CTF for the RMI’s future, the authorities need to be very cautious when choosing investment strategy. Once the Compact grants and the United States’ contributions to the CTF terminate in FY2024, the CTF would be the main financial resource that the RMI government can rely on to finance expenditures. Therefore, the authorities cannot afford to take any significant risks on the CTF, and need to adopt a conservative approach in the investment strategy. A nominal annual return of 8 percent or more will likely require an investment strategy that goes beyond the conservative approach.

19. Additional contributions from donors could reduce the rate of return needed to build up sufficient CTF balance by FY2023. The table below shows the annual surplus/shortfall of the CTF, given the various combinations of nominal investment returns and additional contributions from donors. Not surprisingly, both higher returns and contributions to the CTF reduce the shortfall. Nevertheless, eliminating the shortfall altogether inevitably requires either very high investment returns, or an implausibly generous support from donors. For example, even with annual nominal returns of 7 percent on CTF investments and an additional $10 million a year from donors, the annual shortfall would be substantially reduced, but not fully eliminated.

Compact Trust Fund: Annual Shortfall or Surplus in FY2024 Under Various Scenarios 1/(In millions of U.S. dollars)
6 percentAnnual Return of:

7 percent
8 percent
Additional annual contribution of:
US$ 2.5 million-20.5-9.63.4
US$ 5 million-18.5-6.87.1
US$ 10 million-14.5-1.214.4
Source: Fund staff estimates.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 of $47 million.

Source: Fund staff estimates.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 of $47 million.

Policy action: fiscal consolidation

20. The strategy that has the best chance of allowing the RMI to achieve fiscal sustainability after FY2023 involves substantial fiscal consolidation. The RMI needs to run sizable fiscal surpluses during the period until FY2023. These surpluses will help to achieve budgetary self-sufficiency in two ways. First, they will provide additional financial reserves that can be added to the CTF and will increase its balance in FY2023. Second, and more importantly, the surpluses will create a wedge between budget revenues and expenditures, making the elimination of Compact grants in FY2024 less painful for the budget. In other words, running fiscal surpluses will mean that the adjustment to life without grants is made gradually and beforehand, instead of all at once in 2024.

21. The alternative (policy action) scenario involves a substantial fiscal adjustment starting in FY2009. Like the baseline scenario, it assumes that the CTF receives no new contributions from any donors beyond what has already been pledged. It also continues to assume nominal annual returns on CTF investments of 6 percent. Unlike in the baseline scenario, however, it is assumed that the authorities achieve a small fiscal surplus of around ½ percent of GDP in FY2009, and increase this surplus to around 3½ percent of GDP by FY2013 (Figure I.1).1 The surplus then stays at that level until FY2024, when it decreases to the baseline scenario level of ½ percent of GDP (the level needed to make debt payments on schedule). This fiscal adjustment will require substantial cuts to current expenditure in the short term, and measures to raise additional revenue in the medium term.2

Figure I.1.Marshall Islands: Long-Term Fiscal Adjustment Scenarios: FY2007–30 1

(In percent of GDP)

Source: IMF staff estimates.

1 From FY2024 onward, interest income from the trust fund is considered as part of domestic revenue.

22. Projections show that this strategy can succeed in achieving budgetary self-sufficiency. Additional reserves added to the CTF are projected to increase its balance in FY2023 by $100 million, and provide additional earnings of $6 million that can be used to finance budgetary expenditures. More importantly, however, running sustained fiscal surpluses of 3.5 percent of GDP would result in a surplus of $17 million by FY2023, therefore reducing by the same amount the value of Compact grants that will need to be replaced. Together, these two factors would help to eliminate the shortfall of $22.5 million in the baseline scenario.

23. The fiscal consolidation will be difficult, and will have to be accompanied by structural reforms to improve real growth. The current size of the government sector is not sustainable, and delaying the adjustment will only make it harder for the country to adjust and achieve sustainable growth in the longer term. Nevertheless, given the current size of the government sector and its dominant role in economic activity, fiscal adjustment will inevitably be painful, and is likely to negatively affect growth. Fiscal consolidation will therefore need to be complemented by structural reforms to boost private sector growth, which will be vital to absorb redundant labor from the public sector and ameliorate the impact of declining external support.12

Marshall Islands: CTF: The Baseline Versus the Policy Action Scenario
Baseline: no policy

Policy action: structural

reforms and fiscal

Millions of US Dollars
CTF in 2023678.6778.9
Compact grants in 202347.047.0
Compact grants net of fiscal surplus47.030.6
Earnings available for withdrawal 1/24.530.7
Annual surplus (+) or shortfall (-) 2/-22.50.1

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 net of fiscal surplus

Source: IMF staff calculations

Maximum amount that can be withdrawn, so that the real value of the CTF does not decline.

Calculated as earnings available for withdrawal minus the Compact grants in 2023 net of fiscal surplus

Source: IMF staff calculations

24. Depending on the success of structural reforms, the required fiscal consolidation may be slightly smaller than in the scenario above. The scenario presented above assumes that the authorities implement modest reforms, resulting in an increase of real GDP growth to 2.3 percent per year (compared to 1.8 percent under the baseline scenario). More ambitious and successful reforms (for example, increasing real GDP growth to 2.7 percent) would produce additional $4 million in budget revenues by FY2023, thereby reducing the necessary fiscal surplus by about ½ percent of GDP.

D. Conclusions

25. Without decisive policy action, the CTF will not be sufficient to replace grants that will terminate after 2023. Projections show that obtaining additional funds from donors, securitizing future CTF contributions, and achieving higher returns on CTF investments can improve the situation, but is not likely to resolve it. Furthermore, risks and benefits need to be carefully assessed, when making decisions on securitization of CTF contributions and when choosing investment strategy, so that the most important financial asset of the country (the Compact Trust Fund) is not jeopardized.

26. Substantial fiscal consolidation in the short-term is necessary to achieve budgetary self-sufficiency after 2023. Achieving a fiscal surplus of between 3 and 3½ percent of GDP (depending on the success of structural reforms) within the next 5 years, and then maintaining it until 2023, should be enough to achieve budgetary self-sufficiency. This is undoubtedly a challenging task. However, alternatives are lacking, and delaying reforms will only result in a more painful adjustment in the future.


    Geithner, T., F.Gianviti, G.Häusler, and T.Ter-Minassian,2003, “Assessing Public Sector Borrowing Collateralized on Future Flow Receivables,”International Monetary Fund, Washington DC.

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    Government Accountability Office (GAO), 2007, “Compacts of Free Association: Trust Funds for Micronesia and the Marshall Islands May Not Provide Sustainable Income,”Report to Congressional Committees.

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    Ketkar, S., and D.Ratha,2001, “Development Financing During a Crisis: Securitization of Future Receivables,”Policy Research Working Paper No. 2582, World Bank, Washington DC.

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    N’Diaye, P.,2006, “Compact Trust Fund: Lessons from the Pacific,”IMF Country Report No. 06/97,International Monetary Fund, Washington DC.

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Prepared by Dmitriy Rozhkov (ext. 39745).


In FY2007, foreign grants accounted for about 62 percent of total revenue of the RMI budget. Compact grants accounted for about two thirds of total foreign grants.


The CTF Committee consists of 7 members. Four members represent the United States, two represent the RMI government, and one represents Taiwan Province of China.


Further details on the setup and governance arrangements of the CTF can be found in N’Diaye (2006).


This assumption on nominal returns is similar to the assumption made in GAO (2007).


This scenario also assumes that the RMI government is able to maintain a small fiscal surplus of about ½ percent of GDP, which would be necessary to make the scheduled debt payments over the medium term (see IMF Staff Report for the 2008 Article IV Consultation with Marshall Islands). This surplus, however, is not sufficient for the RMI government to make any additional contributions to the CTF.


The amount of $2.5 million per year is used in this example, because it implies the existence of a new donor with contributions equal to those of Taiwan Province of China, and an amount larger than that does not appear realistic. Similarly, the period starting from FY2010 is used, because currently there are no new donors that expressed willingness to contribute to the CTF, and FY2010 is probably the earliest period when any extra money can be expected.


One example of securitization of future flows in the case somewhat similar to that of RMI is the International Finance Facility for Immunization Company (IFFIm). This organization used securitization of future legally binding grants from its sovereign sponsors to accelerate the availability of funds to be used for health and immunization programs. Details can be found at


The general case of sovereign and public sector borrowing collateralized with future receipts instead of existing assets was analyzed in Geithner, Gianviti, Häusler, and Ter-Minassian (2003). Potential problems associated with such borrowing identified in that paper include: constraints on the flexibility of debt management; possible increases in future (and perhaps current) financing costs; excessive debt accumulation and the related erosion of the sustainability and future flexibility of fiscal policy; nontransparencies in the borrowing arrangements; and potential hindrances to privatization of public enterprises.


The fiscal balance in FY2008 is projected to be -0.3 percent of GDP (based on the FY2008 Budget and the preliminary results for the first two quarters of the fiscal year).


Chapter 2 and the Staff Report for the 2008 Article IV consultation with the Marshall Islands provide details on specific measures that can be taken to achieve these goals.


Staff Report for the 2008 Article IV consultation with Marshall Islands provides details on some specific structural reforms that could be undertaken.

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