Federated States of Micronesia
Recent Economic Developments

This paper reviews economic developments in the Federated States of Micronesia during 1994–97. Real GDP growth, which has been sluggish in recent years, contracted by 4 percent in FY1997. This mainly reflects a sharp reduction in government expenditures under the reform program implemented by the national and state governments since FY1996, the cornerstone of which is the reduction in workforce and wage levels of government employees. The 1996 official GDP data indicated that government services accounted for 42 percent of GDP, wholesale and retail trade for 22 percent, and agriculture, hunting, and forestry for 17 percent.

Abstract

This paper reviews economic developments in the Federated States of Micronesia during 1994–97. Real GDP growth, which has been sluggish in recent years, contracted by 4 percent in FY1997. This mainly reflects a sharp reduction in government expenditures under the reform program implemented by the national and state governments since FY1996, the cornerstone of which is the reduction in workforce and wage levels of government employees. The 1996 official GDP data indicated that government services accounted for 42 percent of GDP, wholesale and retail trade for 22 percent, and agriculture, hunting, and forestry for 17 percent.

Federated States of Micronesia: Basic Data, 1992/93-1996/971/

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates and projections.

On a fiscal year basis; the fiscal year ends on September 30.

As the Federated States of Micronesia has no price index, prices are estimated by the staff based on trends in the United States and the Marshall Islands.

3/Estimated stock of domestic arrears in Chuuk state; end of period.

Government and public enterprise debt only.

Indicator of official reserves. Excludes $71 million in notes issued under the Yap Monetization Scheme.

I. INTRODUCTION

1. The Federated States of Micronesia (FSM) is a confederation of four independent states: Chuuk, Kosrae, Pohnpei, and Yap, comprising 607 volcanic islands and coral atoll sin the Northern Pacific, covering a total land area of 270 square miles and an exclusive economic zone of over 1 million square miles. Each state is headed by a governor and guided by its ownconstitution, which determines the relative balance of powers between the executive, the legislative, and the judiciary, as well as between the state and municipal levels of government. The national executive is headed by a president elected from among the 14 members of the unicameral National Congress, which comprises ten senators representing districts apportioned by population and one senator from each of the four states. The population is 111,000, of which 56,000 live on Chuuk and 36,000 on Pohnpei. While population growth has been rapid at 3 percent per annum, migration mostly to the United States in recent years has contributed to a net population growth of some 1.3 percent a year.

2. FSM was part of the United Nations Trust Territory of the Pacific Islands, under U.S. administration during the period from 1947-86. A Compact of Free Association with the United States (compact) came into effect in 1986 for a 15-year period to 2000/01,1 under which the United States retains authority and responsibility for security and defense matters in exchange for financial assistance, presently equivalent to about 35 percent of GDP, down from 45 percent, reflecting a step reduction of grants in FY1997. Financial assistance includes annual block grants of $60 million for the first five years, $51 million for the next five years, and $40 million for the final five years, as well as amounts for special projects, all subject to a partial annual inflation adjustment. U.S. federal agencies also provide grants for specified purposes, including for health, education, and marine surveillance projects.

II.OUTPUT AND PRICES

A. Output

3. Real GDP growth which has been sluggish in recent years contracted by 4 percent in FY1997 (Table 1).2 This mainly reflects a sharp reduction in government expendituresunder the reform program implemented by the national and state governments since FY1996, the cornerstone of which is the reduction in workforce and wage levels of government employees. The 1996 official GDP data indicated that government services accounted for 42 percent of GDP, wholesale and retail trade for 22 percent, and agriculture, hunting, and forestry for 17 percent (Table 2).

Table 1.

Federated States of Micronesia: Gross Domestic Product, 1992/93-1996/97 1/

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Financial year ending September 30.

Includes depreciation and self-employment income.

Staff estimates based on trends in the Marshall Islands’ CPI and U.S. GDP deflator.

Table 2.

Federated States of Micronesia: Gross Domestic Product, 1996

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and the Asian Development Bank.

4.Fisheriesin the FSM consist of commercial fishing in FSM’s exclusive economic zone that are mainly undertaken by foreign fleets under license agreements, and inshore subsistence fishing carried out by Micronesians for domestic consumption. Commercial fishing is centered on the export of tuna, mainly to Japan. Fish accounted for 82 percent of exports in 1996 (the most recent year for which data is available) and the value of exports has fallen by two-thirds since 1994 due to the withdrawal of Chinese fishing operations from FSM. In recent years, the state and national governments made substantial investments in fishing fleets, shore facilities, and processing plants. These individual and joint-venture operations proved unprofitable and many either have since been liquidated or are in receivership. Based on these past failures, the government’s current fisheries policy is to avoid direct involvement in commercial fishing operations in favor of initiatives to support private sector activities. These would include continued improvement of port and on-shore facilities to attract greater transhipment and processing of fish through FSM by foreign fleets. Reliance on fees from licensing arrangements is to be emphasized. In FY1996-97, earnings from fishing fees accounted for some 30 percent of consolidated government domestic revenue.

5.Agricultureis dominated by subsistence production for individual household consumption with a relatively low level of commercial activity. Production ofcopra, the main commercial and cash crop, continues on a long-term downward trend, reflecting the aging tree stock; export of copra virtually stopped by 1996. The Coconut Development Authority (a national agency) continues to purchase copra (at higher-than-market rates) for export or sale to processing plants. Only the Pohnpei state-owned plant is operational, while the Chuuk state plant has ceased operations from a lack of working capital and management expertise.Reflecting the national and state government policies for the diversificationof agriculturalproduction, some gains in the production and exports of betel nuts, bananas, black pepper, and citrus products have been made over the past few years.Manufacturingactivity through a garment factory in Yap and production of buttons from trochus shells has remained moderate. Tourismactivity continues to be limited to niche markets, including ecotourism and ship-wreck diving in Chuuk and Yap. Average annual travel arrivals to FSM is estimated to be steady at around 25,000, of which some 60 percent could be classified as tourist.Growth in tourist arrivals remains hampered by the lack of infrastructure and distance from potential markets, while the development of resorts is hindered by the complex land tenure system and environmental concerns.

6. The Public Sector Reform Program(PSRP) was initiated in 1996 in anticipation of the substantial step-down in and possible termination of U.S. compact grants. It was primarily designed to correct large imbalances in the public sector and external accounts and to make the economy more self-reliant by reducing the dominant role of the public sector in economic activity, particularly fisheries, agriculture, and tourism. The level of development and economic situation of individual states differed and thus required the development of specific reform strategies. A complex framework of measures to achieve the program’s objectives were nevertheless agreed to and received the endorsement of broad groups of FSM citizens at economic summits held at the state and national levels. This program is supported by the donor community and the AsDB is providing financial support with concessional loans amounting to $18 million to be disbursed in two tranches.

7.Both the national and state governments recognize the potential for foreign investmentto play an important role in expanding and diversifying the productive base, and in supporting the promotion of private sector activity. A new foreign investment act was enacted in 1997 and remains to be ratified by the individual states. The new law would increase the transparency of the approval and regulatory framework, clarify jurisdiction between the national and state governments, and streamline the licensing procedure However, the remaining impediments to investment yet to be addressed include access to land, its use for collateral, and procedures for land lease.

B.Prices, Employment, and Wages

8.It is estimateu -iat retail pricesdecelerated to 3 percent in 1997 from 4 percent in 1996, reflecting the negative real GDP growth. There is no official consumer price index or GDP deflator, but the authorities estimate price movements based on price changes in the main trading partners, tariff levels, transportation costs, and the limited competition at the wholesale and retail levels. In general, the inflation rate has largely followed that of the United States.

9.Traditionally, public service has played a major role in providing formal sector employment in the FSM, accounting for approximately one-half of total employment. The total number of public sector employees declined by 6 percent on average in FY1996-97, due to the cutback in the government workforce (Table 3). The largest decrease in FY1997 was recorded in Yap where the public sector workforce was reduced by over 11 percent, followed by a 10 percent drop in Pohnpei, where there has been a continuous reduction since FY1994.Employees in the national government, however, increased by 3 percent in FY1997, following a 4 percent decline in FY1996. Data are not collected on unemployment.

Table 3.

Federated States of Micronesia: Public Sector Employment and Wages, 1992/93-1996/971/

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

National and state governments, excluding municipal employees.

There is a structural break.

Table 4.

Federated States of Micronesia: Consolidated General Government Finances, 1992/93-1996/97

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes net lending.

10. Public sector nominal wages fell by 6 percent in FY1997, following a freeze in FY1996, primarily because of the measures under the reform program. Average wages in Chuuk and Pohnpei decreased by 10 percent in FY1997, while for the national government and Kosrae, they dropped by 2 percent. In contrast, wages in Yap rose in the last two years.The average wage of national government employees continue to be well above those of the states. Public sector employees continue to benefit from much higher wages and salaries than private sector employees. There is no national minimum wage policy, although minimum wages are applied in Chuuk and Pohnpei, currently set at $0.85 per hour and $1.35 per hour, respectively, but are loosely enforced.

C.Environmental Issues

11. High birth rates, limited land, and migration to state capitals have contributed to growing environmental problems. The availability and access to safe and reliable drinking water have worsened. An improper and poorly maintained waste management system—under 50 percent of the urban population is connected to sewerage systems—has led to waterborne diseases. Encroachment by homesteaders seeking firewood and crop lands has resulted in deforestation and depletion of vital watershed areas. While fisheries and tourism are important growth sectors, policies to restrict pollution, effectively manage coastal water resources, and preserve the country’s biodiversity need to be further developed. Appropriate national and state environmental regulations exist but enforcement is hindered by limited institutional capacity.

III. PUBLIC FINANCE

12. The formulation of a consistent national fiscal policy is hindered by the structure of relations between the national and state authorities. The national government is responsible for policy coordination, but state authorities have a high degree of autonomy in the implementation of budgetary policies. They have the power to levy a wide range of taxes—including sales taxes and excises on tobacco, cigarettes, fuel, alcohol, beer, soft drinks, car rentals, and hotel accommodations—and all forms of fees and licenses, and to determine the level and composition of expenditure. While the national government imposes taxes on imports and income, 80 percent of the fuel import tax and 50 percent of other import and income taxes accrue to the treasury of the state where they are collected (starting in October 1998, the latter percentage would increase to 70 percent, but the increase resources must be earmarked for capital expenditures in the areas of health and education). U.S. compact grants are automatically redistributed to the states according to set formulas and, as a result, the national government acts only as an administrator of such flows and cannot alter their terms or uses. In addition, a certain portion of compact grants can only be expended for specific purposes. Thus, while general grant funds may be applied to general budgetary expenditures, special funds are earmarked for specific uses, particularly in the health and education areas, and cannot be diverted to other uses, and the use of capital funds is limited to approved public investment outlays, which in some states are allocated down to the municipality level, and thus may not be redeployed elsewhere. The national congress plays an important role in determining the spending of the proceeds from fish licensing fees, the major source of revenue accruing to the national government (the states have mounted a challenge in the courts regarding the manner in which such resources are utilized).

A. Consolidated Budgetary Developments in 1995/96 and 1996/97

13. The overall surplus of the consolidated general government rose to 7 percent of GDP in FY1996 but fell back to 1.5 percent in FY1997, owing to the step-down in compact grants (Table 4). Outstanding domestic payments arrears (incurred by Chuuk and Pohnpei states) rose to $17 million in FY1996 and remained at that level in the following year. The reform measures led to a sharp reduction in current expenditures, while domestic revenue remained unchanged at about 31 percent of GDP. In line with the strategy of the adjustment program, the size of the public sector declined significantly at both the state and national levels (see Box 1 for a summary of the envisaged measures).

14.External grants continued to account for a significant part of budgetary revenue, equivalent to 51 percent of GDP in FY1996, but falling to 43 percent in FY1997 with the last five-yearly step-down in compact grants. Current grants continued to account for some 70 percent of total grants, and in FY1997 such grants covered more than one-half of consolidated current expenditures, for some states more than 75 percent. One-third of domestic revenue was derived from tax receipts which, at just below 11 percent of GDP, remained low relative to comparable countries in the Pacific region.3 Tax receipts at the national level were stagnant, reflecting the fall in economic activity in FY1996-97, while the tax effort at the state level improved with a tightening of tax administration and the collection of tax arrears. Nontax receipts continued to be dominated by fishing license fees, which represented a third of total domestic revenue, but the absolute level of receipts stagnated in recent years as foreign fishing vessels withdrew operations. Noncompact external grants declined gradually reflecting lower U.S. federal grants for public works (Table 5).

Table 5.

Federated States of Micronesia: U.S. Grants Under the Compact of Free Association, 1992/93-1996/97

(In millions of U.S. dollars)

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Source: Data provided by the Micronesian authorities.

Section 217 states that the amounts provided in Sections 211, 212, 214, and 215 shall be adjusted for each fiscal year by the percent that equals two-thirds of the percentage change in the U.S. GNP implicit price deflator, or 7 percent, whichever is less in any one year.

Total grants are higher than those shown in Table 4 as not all non-U.S. grants are channeled through the national or state governments.

15.Current expenditure fell to 63 percent of GDP in FY1996 and further to 59 percent in FY1997. The decline in FY1996 was a result of tight controls on outlays of goods and services, particularly for travel; in FY1997, it was due to the reduction in wage rates, a freeze on wage increases, and the elimination of vacant positions. Capital expenditure was held to around 13 percent of GDP in the last two fiscal years, somewhat lower than it had been in the previous years.

B.National Government Finances

16. The overall balance of the national government continued to register surpluses, but they have declined in recent years (Table 6). In FY1997 grants decreased from the compact step-down, while other nontax receipts fell as a result of a suspension of the passport sales program after running into some political problems. Tax receipts were marginally lower despite the sharp slowdown in economic activity, reflecting improved tax administration efforts. Current expenditure was reduced by 12 percent, largely reflecting a reduction in outlays on goods and services. However, the impact of the reform measures on the wage bill was negligible, in part reflecting delays in the implementation of the downsizing and early retirement program.3

Table 6.

Federated States of Micronesia: National Government Finances, 1992/93-1996/97

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes net lending.

Federated States of Micronesia: Fiscal Measures, FY1996-98

Expenditure

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c.Other measures

  • following reductions, a wage freeze

  • following reductions, a freeze on travel expenses

  • merging government departments and ministries

  • outsourcing of certain services

Revenue

Targeted increase of 20 percent each for Chuuk and Pohnpei, 30 percent for Yap, 5 percent for Kosrae, and 40 percent for the national government. Increase to be achieved by:

a. Adjusting import duties to c.i.f. from f.o.b. basis.

b. Raising state taxes.

c. Reducing exemptions on import duties and GRT.

d. Strengthening tax and customs administration, reducing tax arrears.

e. Combining state and national agencies into a unified federal tax department.

f. Increasing user fees and charges.

C. Fiscal Developments in States

17. After facing a severe financial crisis in FY1995, the state government of Chuuk took measures to reduce expenditures, which led to the generation of surpluses in FY1996 and FY1997 (Table 7). However, payment arrears continued to be accumulated in FY1996; with financial assistance from the national government, the stock of arrears was reduced in FY1997 and is scheduled to be reduced further in FY1998 and be eliminated by FY1999. There were problems in FY1996 in the collection of tax receipts linked in part to Chuuk’s arrears to suppliers. These problems were resolved in FY1997 and tax receipts rose by 85 percent, reflecting in part reduction in tax arrears and improved collections.However, revenue measures involving an increase in sales taxes from 3 to 5 percent, a tax on luxury items of 10 percent, and increases in fees and charges for certain services arestill under consideration in the legislature. In the expenditure area, wages were effectively reduced by 20 percent with the introduction of a four-day week in FY1996, a freeze in general wage adjustments, and a halt in new hiring. The size of the government workforce was reduced by some 13 percent by FY1997 compared to a targeted reduction of 29 percentby FY1999. In all, outlay on wages has fallen by 23 percent since FY1995. A travel freeze and stricter scrutiny on other outlays of goods and services helped to bring this category of expenses under better control. Nevertheless, the finances of Chuuk state remained vulnerable. Domestic revenue still only covered a little over one-third of current expenditures and additional adjustments would clearly be needed to achieve greater self-reliance.

Table 7.

Federated States of Micronesia: Chuuk Government Finances, 1992/93-1996/97

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes transfers from the national government.

Includes net lending.

18. The overall balance of the state government of Kosrae recorded a small deficit in FY1996 and was in virtual balance in FY1997 (Table 8). The levels of total revenue and grants and current expenditures have fluctuated narrowly in recent years. The deficit in FY1996 was the result of ongoing capital outlays on infrastructure and was financed mainly out of holdings of capital funds from the previous year’s grant disbursements. In FY1997, with the step-down in compact grants, the Kosraen authorities implemented the agreed reform measures which contributed to a 17.5 percent reduction in current expenditures. The authorities have already reduced the government workforce by 17.5 percent, substantially ahead of the target date of FY1999, and much more than the reduction of 13 percent envisaged. In addition, a wage reduction of 12.5 percent was put in place with the FY1998 budget. Kosrae is especially dependent on external grants, as domestic revenue cover less than 30 percent of current expenditures. The authorities are considering further measures in the expenditure and revenue areas to reduce their reliance on external grants.

Table 8.

Federated States of Micronesia: Kosrae Government Finances, 1992/93-1996/97

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes transfers from the national government.

Includes net lending.

19.After registering a large overall surplus in FY1996, the fiscal position of the state of Pohnpei turned into a deficit in FY1997 as it failed to adequately adjust to the step-down in compact grants (Table 9). Its outstanding stock of payments arrears rose to $3 million by end-FY1997. In FY1996, strict control on expenses for good and services, especially travel, reduced outlays, but the gains were reversed in FY1997. While the payroll was reduced in FY1997 with a halt in new hiring, a moratorium in promotions, and a freeze on wage increases, an effective wage decrease of 20 percent by reducing the work week was only put in place in the latter half of FY1997. Under the reform program, the number of government employees was reduced by 13 percent compared to a target of 23 percent. The envisaged revenue measures and additional downsizing of personnel have been considerably delayed by the state legislature. Measures include raising sales taxes to a single rate of 7 percent from 1-3 percent and extending the tax to include food items. Without these measures, Pohnpei would likely be faced with a financial crisis in FY1998, similar to that experienced by Chuuk in FY1995. Like Chuuk, Pohnpei has also approached the national government for financial assistance to help bridge the financial shortfall, but the assistance would not be forthcoming until the proposed measures are implemented.

Table 9.

Federated States of Micronesia: Pohnpei Government Finances, 1992/93-1996/97

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes transfers from the national government.

Includes net lending.

20.The overall balance of the state of Yap swung to a surplus position in FY1996 and FY1997, after registering sizable deficits in recent years(Table 10). Tax receipts increased with improvement in tax administration and collection and there was a gain in investment earnings in FY1996. With the step-down in compact grants, Yap also agreed to implement the reform measures to reduce current expenditures. Yap is in a somewhat less vulnerable position as its payroll has always been modest. Yap has already reduced government employment by 23 percent, compared to a target of 28 percent. Domestic revenue covered 55 percent of current outlays in FY1997.

Table 10.

Federated States of Micronesia: Yap Government Finances, 1992/93-1996/97

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Includes transfers from the national government.

Includes net lending.

D. Nonfinancial Public Enterprises

21.The reform measures included reducing subsidies to public utilities and striving toward a pricing policy that required complete cost recovery by all state entities. Except for Chuuk state all other state utility companies have been able to attain this objective by FY1997.The Chuuk state utilities began with a much weaker financial position, but appear to have formulated a plan to attain the cost recovery objective over the next few years.

22.The Telecommunications Corporation continues to be a profitable entity, providing domestic and international services, although it has received considerable financial assistance from the United States. Efforts to restructure and privatize commercial operations in fishing and agriculture have progressed very slowly. Pohnpei state has made advances in preparing the Fisheries Corporation for privatization and is pursuing interested buyers. The national government continues to provide financial support to the National Fisheries Corporation and the Coconut Development Authority; the Pohnpei state government assists transportation, housing, and port operations; and the Yap state government subsidizes fishing and public transportation.

E. Social Security Administration

23.The Social Security Administration (SSA) is a self-financing autonomous institution whose operations and entitlements, including old age, survivors, and disability benefits, are paid out of contributions and investment income. Revenue from contributions has persistently exceeded entitlement payments and administrative expenses (Table 11). Moreover, contribution rates, which are applied in equal proportions to employees and employers, were raised from 4 percent to 5 percent of gross salary in 1995. The financial holdings of the administration, which are mostly invested in U.S. securities, continue to be equivalent to four years of benefit payments at end-FY1997. The latest interim actuarial report, which takes into account the impact of the reform measures on public employment and contributions to SSA, indicate that benefit payments would start to exceed contributions in FY1999. This negative position is likely to persist and even worsen through the end of the compact in 2001.

Table 11.

Federated States of Micronesia: Social Security Administration, 1992/93-1996/97 1/

(In millions of U.S. dollars)

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Source: Data provided by the Micronesian authorities.

Years ending March 31.

iv.FINANCIAL SECTOR

A. Background

24.The financial sector consists of three commercial banks (the Bank of the Federated States of Micronesia, the only domestically owned bank with offices in each of the four states, and two U.S. banks, the Bank of Guam with offices in Pohnpei and Chuuk, and the Bank of Hawaii with offices in Pohnpei, Kosrae, and Yap); the Development Bank of the Federated States of Micronesia; six insurance companies; and four credit unions. There is no central monetary authority and the U.S. dollar is the currency of FSM. Deposit sin all three commercial banks are protected by the U.S. Federal Deposit Insurance Corporation.

25. Supervision of commercial banks is exercised by the Banking Board established in the Banking Act in 1980, and headed by a banking commissioner. With IMF technical assistance, directly and through the Pacific Financial Technical Assistance Centre (PFTAC), supervision functions of the Board have steadily improved. The Board has established prudential norms and has improved capital and other regulatory requirements, and is now able to review indicators of the financial situation of commercial banks reported on a monthly basis.The Bank Commissioner has conducted on-site visits to all bank branches, except one bank each in Kosrae and Chuuk. The Board has authority to license banks and, in early 1998, the requirement for annual renewal was eliminated; banks are now licensed until withdrawal for defined infractions. The regulation that banks should not transfer abroad more than 50 percent of deposits received from local residents and domestic corporations was also eliminated in late 1997. The supervision and licensing of the Development Bank, insurance companies, and the credit union continue to be outside the jurisdiction of the Banking Board.

26.Consumer loans continue to account for some two-thirds of total loans and are contracted primarily by public sector employees and other salaried workers for the purpose of travel, family celebrations, home improvements, and education. These loans are usually repaid through a system of automatic deductions from employer’ payrolls.Commercial loans are made to public enterprises and the private sector for working capital and equipment purchases. Long-term lending remains very limited in view of the small number of viable projects and are hampered by the inflexible land tenure system which prevents banks from using land as collateral or for leasing arrangements.

B. Recent Developments

27.Reflecting the fall in economic activity, commercial bank lending contracted by 11 percent in 1996 and a further 3 percent in 1997 (Table 12). The steep fall in 1996 reflected the fiscal crisis in Chuuk which led to a severe curtailment of consumer lending, as the state government failed to make allotment payments to cover employee loan obligations and the employment outlook turned sharply negative. Banks were required to charge of fnonperform-ing consumer loans which lowered profitability. Commercial loans remained unchanged in 1996-97 implying a fall in real terms.

Table 12.

Federated States of Micronesia: Banking Survey, 1993-97

(In millions of U.S. dollars; end of period)

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Source: Data provided by the Micronesian authorities.

Includes reserves for possible loan losses.

28. There was an increase in bank deposits in 1996, attributed in part to an increase in time deposit interest rates (Table 13). In 1997, deposits fell as the decline in economic activity took hold. However, the loan-deposit ratio fell sharply over the last two years to 39 percent by end-1997. Claims on foreign banks increased as a result by 16.5 percent in 1995-97 to $80 million.

Table 13.

Federated States of Micronesia: Interest Rates of Deposit Money Banks, 1993-971/

(In percent per annum; end of period)

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Source: Data provided by the Micronesian authorities.

Average of rates offered and charged by deposit money banks.

Deposit rates are calculated using the average savings and time deposits of each bank, divided into the total interest paid for the year for that deposit category.

29.Average interest rates on savings deposits rose in 1996 by 0.5 percentage points to 3 percent and those on time deposits rose by 1.5 percentage points to 4.9 percent. Time deposit rates fell to 4.3 percent in 1997 and such deposits accounted for 50 percent of all deposits. Interest rates on consumer loans remained unchanged at 15 percent throughout this period while the average rate on commercial loans has fallen by 0.5 percentage points to 10.8 percent in 1997. In early 1998, interest rate ceilings on commercial loans were eliminated subject to a usuary ceiling of 24 percent, and the ceiling on consumer loans is to be removed by September 1998.4 The ratio of delinquent loans has been reduced to 2-3 percent of the loan portfolio in 1997 from 7 percent in 1995 and, with large charge-offs, the equity-to-asset ratio has fallen.

30.After falling slightly in 1996, the private sector loan portfolio of the Development Bank rose to $32 million(Table 14). Loans to the fisheries sector continued to dominate the portfolio, followed by credits to the manufacturing sectors. Nonperforming loans amounted to about 10 percent of the total loans. Interest rates on new loans remained at 9 percent, for an average term of seven years.

Table 14.

Federated States of Micronesia: Assets and Liabilities of the Development Bank of the Federated States of Micronesia, 1993-971/

(In millions of U.S. dollars; end of period)

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Source: Data provided by the Micronesian authorities.

The fiscal year changed from September to December in FY1994.

Reflects investment abroad and Investment Development Fund (IDF) resources.

Reflects the final distribution from the Trust Territories of the Pacific Islands Economic Development Loan Fund; this is being kept as a cash reserve. In FY1994, all funds other than the IDF and the states’ private funds were converted to stock equity by the national government and the state of Kosrae.

V.EXTERNAL SECTOR

31. The current account deficit, excluding official transfers, narrowed sharply by about one-half over the past two years to less than 18 percent in FY1997, reflecting the compression of imports from the decline in economic activity arising from the sharp decrease in government expenditure(Table 15). With the absence of new borrowings, large medium-term capital outflows continued in FY1996, but the medium-term capital account swung into a small surplus in FY1997 with the disbursement of the first tranche of the AsDB public sector reform loan of $10 million. It is believed that continued large negative errors and omissions reflect overestimation of exports (particularly fish reexports), service receipts and accounting for official transfers. Capital account transactions aredifficult to monitor owing to the use of the U.S. dollar and the absence of capital controls, and no official balance of payments statistics are compiled by the authorities. The overall balance of payments position, measured by changes in the consolidated financial holdings of the government, improved sharply in FY1997 as public finances strengthened.4

Table 15.

Federated States of Micronesia: Balance of Payments, 1992/93-1996/971/

(In millions of U.S. dollars)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

Financial year ending September 30.

Based on official statistics for the calendar year; supplemented for coverage deficiencies.

Includes social security fund investments, public enterprises’ escrow accounts, and errors and omissions.

Reflected in changes in the financial holdings of the national and state governments.

A. Merchandise Trade

32. Exports and reexports continued to fall sharply in recent years to 15 percent of GDP by FY1997 from some 30 percent in FY1995. This decline is explained by a precipitous fall in fish exports in FY1996-97, due to the withdrawal of a Chinese fishing operation from FSM and lower fish landings by Japanese vessels. Nevertheless, in 1997 fish exports still accounted for more than 80 percent of total exports (Table 16). Among minor exports, betel nut and pepper expanded notably and garments have grown steadily, while all other items remained stagnant and copra exports have disappeared. Imports also decreased significantly to the equivalent of 40 percent of GDP in FY1997 down from 80 percent in FY1994. Food and beverages continued to take up the largest share of total imports (29 percent), followed by mineral fuels (18 percent), and manufactured goods (16 percent) (Table 17). The United States remained the dominant source of imports, accounting for 70 percent of all imports in 1996, followed by Japan with 13 percent (Table 18).

Table 16.

Federated States of Micronesia: 1mports by Major Product Category, 1992-96 1/

(In thousands of U.S. dollars, unless otherwise specified)

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Sources: Data provided by the Micronesian authorities; and Fund staff estimates.

On a calendar-year basis.