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© 2005 International Monetary Fund
March 2005
IMF Country Report No. 05/104
Federated States of Micronesia: 2004 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Federated States of Micronesia
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2004 Article IV consultation with the Federated States of Micronesia, the following documents have been released and are included in this package:
the staff report for the 2004 Article IV consultation, prepared by a staff team of the IMF, following discussions that ended on October 28, 2004, with the officials of the Federated States of Micronesia on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on February 25, 2005. The views expressed in the staff report are those of the staff team and do not necessarily reflect the views of the Executive Board of the IMF.
a Public Information Notice (PIN) summarizing the views of the Executive Board as expressed during its February 25, 2005 discussion of the staff report that concluded the Article IV consultation.
a statement by the Executive Director for the Federated States of Micronesia.
The document listed below has been or will be separately released.
Selected Issues and Statistical Appendix Paper
The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information.
To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to publicationpolicy@imf.org.
Copies of this report are available to the public from
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INTERNATIONAL MONETARY FUND
FEDERATED STATES OF MICRONESIA
Staff Report for the 2004 Article IV Consultation
Prepared by the Staff Representatives for the 2004 Consultation with the Federated States of Micronesia
(in coordination with other departments)
Approved by David T. Coe and Michael Hadjimichael
December 28, 2004
A staff team comprising Messrs. Kramer (head), Komori, Ginting (all APD), and Mr. Christensen (OTM) held the Article IV discussions in Pohnpei during October 18–28, 2004. The mission overlapped with visits by a PFTAC team and an MFD expert.
The team met with President Urusemal, Vice President Killion, Secretary of Finance and Administration Andon, Secretary of Foreign Affairs Anefal, and other senior officials. It also met with representatives of Pohnpei state government.
The mission conducted a number of outreach activities, meeting with representatives of the National Congress, the banking and business communities, a local research institute, and a newspaper.
In concluding the prior consultation in January 2003, Directors agreed that the Federated States of Micronesia (FSM) faced major challenges in adjusting to reduced external assistance under the second Compact of Free Association with the United States. They stressed that only with strong fiscal adjustment, structural reforms to stimulate private sector activity, and greater investment in human capital could the FSM look forward to macroeconomic stability and economic growth. Directors recognized that, given the FSM’s structure as a loose federation of autonomous states, the authorities should spare no effort in garnering the needed political and community consensus for reforms.
The FSM has accepted the obligations of Article VIII, sections 2, 3, and 4 and maintains an exchange system that is free of restrictions on payments and transfers for current international transactions.
Contents
Executive Summary
I. Economic Setting
II. Recent Economic Developments and Near-Term Outlook
III. Policy Discussions
A. Medium-Term Framework
B. Fiscal Adjustment
C. Structural Reforms
D. Other Issues
IV. Staff Appraisal
Boxes
1. Renewed Compact of Free Association with the United States
2. The FSM Economy—Comparison with the Other Compact Countries
3. Private Sector Development Program
Tables
1. Basic Data, FY1999–2005
2. Consolidated General Government Finances, FY1999–2005
3. Balance of Payments, FY1999–2005
4. External Vulnerability Indicators, FY1999-2004
5. Social Indicators
Annexes
I. Long-Term Fiscal Adjustment
II. Fund Relations
III. Technical Assistance from Headquarters
IV. Relations with the Pacific Financial Technical Assistance Center (PFTAC)
V. Relations with the World Bank Group
VI. Relations with the Asian Development Bank
VII. Statistical Issues
Executive Summary
Economic Setting
The Federated States of Micronesia (FSM) relies heavily on U.S. grants under the Compact of Free Association. These grants, which are currently sizeable, have been declining and are set to fall further and expire in FY2024. Reflecting large grants, the public sector dominates economic activity.
Success in adjusting to past declines in Compact grants has been mixed. The wage bill was reduced in the 1990s but it remains high relative to GDP. Fiscal discipline has been uneven across the four states, which have budgetary autonomy.
Output contracted in FY2004 with a stepdown in Compact grants but is expected to grow slightly in FY2005. The drop in grants also precipitated deteriorations in the fiscal and external balances. Employment is stagnant, and inflation remains low, notwithstanding rising fuel prices.
Key Policy Issues
Fiscal and structural reforms are needed for the FSM to achieve self-sufficiency. The large government sector will be increasingly unsustainable given coming declines in grants. A sizeable budgetary adjustment is needed to curb fiscal vulnerabilities as well as to build up sufficient assets as a buffer against future shocks. In addition, structural reforms are needed to promote private sector development and employment.
The authorities agree on these priorities, but progress in fiscal and structural reforms may well remain slow. This situation reflects a highly decentralized fiscal system, a lack of understanding among stakeholders of the policy challenges, and capacity limitations.
Fiscal adjustment will need to comprise both expenditure cuts and revenue measures. There is room to rein in current spending, although core health, education and infrastructure spending must be preserved given its importance to growth. The best option to increase revenue remains comprehensive tax reform and the introduction of a VAT; the government is discussing this option but agreement is not likely soon.
Structural reform priorities should include improvements to the legal framework for land use, foreign investment, and lending. Public enterprise reforms could both reduce crowding-out of private firms and yield budgetary savings.
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February 25, 2005
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Public Information Notice (PIN) No. 05/37
FOR IMMEDIATE RELEASE
March 22, 2005
International Monetary Fund
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