Republic of the Marshall Islands
2008 Article IV Consultation: Staff Report; and Public Information Notice on the Executive Board Discussion

The Republic of the Marshall Islands (RMI), scattered across an area of nearly 1 million square miles in the Central Pacific, is heavily dependent on external grants. As in past consultations, the current discussions have focused on policies to put public finances on a secure footing and improve growth prospects. Recent economic performance has been lackluster. Exports have been held back mainly by structural problems. The fiscal position has improved in FY2006, but the overall balance has been slightly negative at about ½ percent of GDP.

Abstract

The Republic of the Marshall Islands (RMI), scattered across an area of nearly 1 million square miles in the Central Pacific, is heavily dependent on external grants. As in past consultations, the current discussions have focused on policies to put public finances on a secure footing and improve growth prospects. Recent economic performance has been lackluster. Exports have been held back mainly by structural problems. The fiscal position has improved in FY2006, but the overall balance has been slightly negative at about ½ percent of GDP.

I. Background

1. The Republic of the Marshall Islands (RMI), scattered across an area of nearly 1 million square miles in the Central Pacific, is heavily dependent on external grants. Like other small Pacific island countries, RMI is remote from major markets, has a narrow production and export base, and is vulnerable to external shocks and climate change (Box 1). The most important aid source has been U.S. financing, primarily through the Compact of Free Association (Compact). The Compact (amended in 2004) extends the U.S. financial support until 2023. Taiwan Province of China has also given substantial aid to support development expenditure and contributed to the Compact Trust Fund (CTF).

2. As in past consultations, this year’s discussions focused on policies to put public finances on a secure footing and improve growth prospects. Achieving this goal will require fiscal consolidation, reform of public enterprises, and other structural measures. Since the last Article IV, the fiscal position has improved slightly, but limited progress has been made on structural reforms, and key tax reforms have not been implemented.

3. National elections at the end of 2007 resulted in a new President and a coalition government. The new government has underscored the need to review various aspects of the amended Compact agreement, especially the land use agreement regarding Kwajalein where the United States operates a military base. In the short run, the new government is not expected to change economic policies significantly, but could provide a fresh impetus to advance reforms.

II. Recent Economic Developments

4. Recent economic performance has been lackluster. Real GDP growth slowed, on average, to 1.3 percent in FY2005–06 (fiscal year ending September 30), from about 4 percent in the previous four years (Table 1 and Figure 1). During FY2006, a financial crisis of the energy company–a public enterprise–required a large cash injection from the government to sustain electricity production.1 The problem was resolved in early FY2007 with the refinancing of $12 million of the company’s expensive short-term debt. Economic activity started to pick up in early FY2007, driven by the construction of a convention center, the refurbishing of a fish processing plant, and the influx of visitors from charter flights. Growth in FY2007 is estimated to have been around 2.3 percent. Unemployment, especially youth unemployment, remains high, contributing to emigration to the United States, which is relatively easy under the Compact agreement.

Table 1.

Marshall Islands: Basic Data, FY2004–08 1/

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

Fiscal year ending September 30.

Cash and cash equivalents that are not reserved for specific uses.

Assets in trust fund are treated as not available for budget financing.

Official transfers include current transfers but exclude capital transfers and Trust Fund contributions.

Large negative overall balance in FY04 reflects official capital outflow to the Compact Trust Fund.

Includes government and government-guaranteed debts.

Figure 1.
Figure 1.

Marshall Islands: Economic Developments

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Sources: Fund staff estimates and RMI authorities.

Selected Economic Indicators

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Sources: Staff estimates, and RMI authorities.

Marshall Islands: Vulnerabilities to Climate Change

With an average elevation two meters (7 ft) above sea level—the highest land elevation is only six meters––RMI is highly susceptible to a rising sea level induced by global warming. Fragile coral reefs fringe the atolls and serve as the only line of defense against ocean surge. Climate change has increased the likelihood of sudden erosion due to storm surges and seasonal typhoons. Coastal erosion is evident throughout the islands. On Majuro Atoll, the airport has flooded several times, despite an eight-foot-high seawall. Water shortages and drought have also struck. The small land area in various atolls and islands leaves little room for adaptation alternatives, such as retreating to higher elevations or building preventive dikes, in face of rising sea levels.

The key economic effects of climate change include:

  • Direct. Nearly half of total exports come from climate-sensitive sectors, such as fishing and copra production. In addition, disruption in air transport would affect tourism and business climate.

  • Budgetary. Additional capital expenditure for either preventive or restorative measures may be required in the medium term. Also, the decline in exports and tourism could mean a reduction of tax revenue.

The authorities are currently engaged in regional and international efforts in raising the general awareness and assessing the vulnerabilities due to climate change. The United States and RMI governments have initiated a disaster fund with the Compact grant of roughly $200,000 per annum to finance potential losses arising from natural disasters. The country is also involved in climate change issues, including the implementation of the United Nations Framework Convention on Climate Change.

5. CPI inflation has risen but remains reasonably contained. Inflation averaged about 4 percent (year-on-year) in the last two years, reflecting higher electricity costs and prices of food and oil. The U.S. dollar is the official currency and has provided a strong anchor for inflation expectations.

6. Exports have been held back mainly by structural problems. Exports declined after the tuna processing plant closed in 2005 and have not recovered. The real effective exchange rate has remained broadly unchanged over the past decade, reflecting a relatively stable inflation differential with the United States, a large trading partner, and a weakened U.S. dollar. Tourism is modest, owing to weak infrastructure and few overseas flights compared to other pacific islands, but RMI has been trying to attract more tourists by using charter flights.2

uA01fig01

Real Effective Exchange Rate Comparisons

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Sources: IMF, Information Notice System; and staff calculations.

7. The fiscal position improved in FY2006, but the overall balance remained slightly negative at around ½ percent of GDP (Table 2 and Figure 2). This outcome masks some of the problems the government faced early in the fiscal year, including difficulty in meeting bi-weekly payroll, missed social security payments, delayed payments to vendors, and arrears to the Asian Development Bank (AsDB). Improvements in collection of taxes (and tax arrears) as well as grants from Taiwan Province of China eased the situation.3 The outcome reflects mainly increased funds from the Compact agreement, some of which were previously delayed. In FY2007, the government’s overall deficit is estimated to have remained roughly constant at ½ percent of GDP.

Table 2.

Marshall Islands: Central Government Finances, FY2004–08 1/

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

The fiscal year ends on September 30.

Does not include Compact funds earmarked for Kwajalein rental payments and trust fund contributions.

In FY05 and FY06, includes grants of $12.7 million and $13.3 million for the construction of the Airport.

For FY05-08, capital expenditure includes additional capital projects financed by Taiwan POC and U.S. grants for the airport.

Cash and cash equivalents that are not reserved for specific uses.

Figure 2.
Figure 2.

Marshall Islands: Fiscal Indicators

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Source: Fund staff estimates and RMI authorities.
uA01fig02

Fiscal Indicators

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

8. The government has fully met its mandatory contributions to the CTF. The CTF is now invested in a portfolio of U.S. and international stocks and bonds, and the income of the fund exceeded projections in FY2006 and FY2007. A conflict between the trustee and the investment advisor over the custodial rights has been resolved.

9. The banking system, which consists of two banks, provides little domestic credit to the commercial sector (Figure 3).4 Around 75 percent of total bank lending is in high-interest short-term consumer loans, rather than commercial loans, owing to the lack of adequate collateral.5 Average bank lending rates tend to be slightly higher in RMI than in other Pacific countries. The non-bank sector consists of one small moneylender and several small money transfer companies that operate with remittances. In addition, one of the banks has recently become involved in microfinance, funded by a $0.7 million government guaranteed loan from Taiwan Province of China. In 2007, a third bank was licensed to operate in the RMI, and is expected to begin banking operations in 2008.

Figure 3.
Figure 3.

Marshall Islands: Financial Developments

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Source: Fund staff estimates and RMI authorities.

10. The current account balance (including current transfers) has improved but was in deficit of 1.6 percent of GDP in FY2006 (Table 3 and Figure 4). The trade deficit remained stable, with a decline in both exports and imports, stemming from a decrease in the re-export of diesel fuel. Net services and income in the current account narrowed slightly, owing to higher pay for local workers employed in the Kwajalein U.S. military base. Current transfers increased, thanks to higher Compact grants. Staff estimate that the net outflow of private transfers is large, reflecting the flow of Kwajalein rental receipts to non-resident landowners.6 In FY2007, the current account (including current transfers) is estimated to be in deficit around 3 percent of GDP, largely reflecting declines in grants, particularly related to infrastructure.

Table 3.

Marshall Islands: Balance of Payments, FY2004-08 1/

(In millions of U.S. dollars)

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

Fiscal year ending September 30.

Compact funding pertaining to the Kwajalein Atoll Trust Fund and Kwajalein resident and landowner compensation payments are classified as income rather than official transfers. Trust Fund contributions by the U.S. and Taiwan, POC, are regarded as capital transfers.

Official transfers include current transfers but excludes capital transfers and Trust Fund contributions.

Includes changes in social security fund investments, banking system assets held overseas, and government assets held in the capital and special fund accounts.

Changes in government assets, excluding the general fund.

Including MIITF which is deposited in domestic financial institutions.

Figure 4.
Figure 4.

Marshall Islands: External Developments

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Sources: Fund staff estimates and RMI authorities.
uA01fig03

Deposit and Lending Rates: Average 2002 -2007

(In percent)

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

uA01fig04

Trade and Current Account Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

11. Gross external debt remains high (Table 4). The outstanding public and publicly guaranteed debt is estimated to be around $100 million, or about 70 percent of GDP at the end of FY2006. This includes $12 million of new publicly guaranteed debt of the energy company. Nearly 60 percent of the outstanding debt is on concessional terms, owed primarily to the AsDB. The remaining is mainly owed by two utility companies in the public enterprise sector. The debt service was $6.3 million in FY2006, or about 20 percent of exports of goods and services, but has risen significantly in FY2007 reflecting repayments of arrears to the AsDB and large interest payments related to the short-term financing for the energy company.

Table 4.

Marshall Islands: External Vulnerability Indicators, FY2004–08

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

Financial indicators are as of end December.

The large increase in financial indicators in 2007 reflect a government guaranteed loan to energy company.

Defined as loans with arrears in excess of 90 days.

Measured by the end-of-period stock of government financial assets held in commercial banks.

III. Discussions with the Authorities

12. Most of the discussions focused on two key issues: achieving fiscal sustainability and boosting private-sector growth. Given the decline in external grants under the amended Compact (and set to expire in 2023) and increases in debt service payments, maintaining the current size of government is not sustainable over the longer term. Fiscal consolidation and structural reforms are therefore needed, to ensure long-term fiscal sustainability and to boost private sector development. There was broad agreement that such reforms would be difficult and challenging. Nevertheless, the government recognized that viable alternatives are lacking, and without these reforms the underlying vulnerabilities are likely to grow.

A. The Outlook and Exchange Rate Regime

13. Activity is slowing with real GDP growth of less than 2 percent a year likely over the medium term. For the immediate future, staff projects growth of about 1.2 percent in FY2008 and 1.8 percent in 2009, constrained by rising energy costs and a large reduction in employment at the military base in Kwajalein (Table 5). The significant loss of revenue from the military downsizing will be partially offset by the launching of a tuna processing plant. High energy and food costs are creating inflationary pressure. The external position is expected to remain roughly balanced, given projected disbursements of foreign grants and limited access to other sources of external financing.

Table 5.

Marshall Islands: Medium-term Scenario, FY2006–13 1/

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

Fiscal year ending September 30.

Cash and cash equivalents that are not reserved for specific uses.

Assets in trust funds are treated as non-usable.

Government and government-guaranteed debt only.

14. Risks to the outlook are on the downside. While infrastructure spending will continue, problems with the energy company could resume, especially if oil prices continue to rise, and the lengthy grounding of the domestic airline could undercut the nascent tourist business. With the United States downsizing its activity on Kwajalein, the knock-on effects on Marshallese employment and revenue could be dramatic. In addition, global financial disturbances could depress the rate of return on the CTF, further undermining fiscal sustainability. Structural reforms to improve the investment climate will be important to safeguard even the baseline growth scenario.

15. Although full dollarization deprives RMI of a policy instrument to help safeguard stability, enhance competitiveness, and deal with external shocks, it is appropriate given RMI’s size, administrative capacity, and close ties to the United States. The authorities underscored that RMI does not have the capacity to conduct independent exchange rate and monetary policy. Over the next fifteen years, external stability is not at risk given the flow of Compact grants until 2023. However, over the longer term (after 2023) insufficient fiscal adjustment could eventually lead to a depletion of the CTF and possibly mounting external debt.

B. Fiscal Consolidation

16. The key issue for external stability in the long term (after 2023) is fiscal sustainability. In this context, the staff urged the government to aim for a modest fiscal surplus in FY2008, recognizing that under the current circumstances it may be difficult to achieve rapid fiscal adjustment without hurting growth. Given the size of adjustment, the staff proposed that fiscal consolidation proceed by ½ percent of GDP per annum for the next 4–5 years, using the surpluses to build reserves in the CTF (Box 2).7 The new government recognized that this adjustment was necessary to achieve the goal of budgetary self-sufficiency by the end of the Compact in FY2023, but indicated that it would be very challenging given its existing expenditure commitments. The staff emphasized that the longer the adjustment is delayed the harder it will be for the country to adjust and achieve sustainable growth in the longer term.

17. The authorities recognized that they would need to make difficult cuts to current expenditure in the short term. The staff noted that the level of current expenditure is not sustainable, and expressed concerns that a sizeable portion of Taiwan Province of China grants are used for financing current expenditure, rather than capital expenditure. The authorities argued that this is necessary since they are facing high debt-service payments and are actively seeking additional donor contributions. The mission advised the following menu of measures be phased in over the next several years to achieve the needed fiscal adjustment:

Marshall Islands: Fiscal Sustainability After 2023

Budgetary self-sufficiency of the RMI after 2023 will depend on whether the earnings from the Compact Trust Fund (CTF) will be enough to offset the elimination of Compact grants. Chapter 1 of the Selected Issues considers several alternative scenarios, some of which are summarized below.

Baseline scenario

The baseline scenario assumes that structural reforms are not undertaken, and the fiscal balance is kept around ½ percent of GDP until 2023, which is adequate for making debt payments, but not for adding reserves to the CTF. Under this scenario, CTF earnings in 2024 (assuming constant real value of the CTF) are projected to be $22.5 million lower than the Compact grants they are supposed to replace.

Alternatives without policy action

Staff projections show that securitization of $100 million of future U.S. contributions to the CTF will only reduce the 2024 shortfall by $1 million. The benefits of securitization therefore do not justify taking additional risks. Similarly, additional help from donors (within the realistic limits) will reduce the shortfall, but not eliminate it. For example, an additional $5 million per year until 2023 will only eliminate less than ¼ of the shortfall after 2023 ($4 million).

Policy action scenario

Structural Reform. This scenario assumes that the a uthorities implement structural reforms only. This action leads to an increase in GDP growth and higher budget revenues, narrowing the fiscal gap in 2024. However, structural reforms alone (without fiscal consolidation) would not be sufficient to eliminate the shortfall, which remains at $20 million.

uA01bx02fig01

Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 185; 10.5089/9781451825930.002.A001

Fiscal Consolidation and Structural Reform. Projections show that, in addition to structural reform, the authorities need to achieve a fiscal surplus of about 3 percent of GDP within 5 years, and maintain it until 2023. This would allow adding reserves to the CTF. In addition, it will result in a substantial fiscal surplus by 2023, reducing the amount of Compact grants that need to be replaced. CTF earnings after 2023 would then be sufficient to compensate for the elimination of Compact grants, and the CTF can be kept constant in real terms, ensuring long-term fiscal sustainability.

CTF Earnings: Annual Surplus (+) or Shortfall (-) After 2023

(US$ millions) 1/

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Source: IMF staff calculations

Calculated as the difference between CTF earnings available for withdrawal in 2024 (so that the real value of the CTF is kept constant) and the Compact grants in FY2023 (estimated at $47 million).

Assumes securitization of $100 million in FY2010, with all incurred debt repaid before FY2023.

  • Other expenditure. The new government plans to cut discretionary expenditure by 5 percent in the FY2009 budget. There was broad agreement that efforts should focus on limiting spending on travel, energy consumption, and use of government vehicles.

18. The authorities acknowledged the need to raise additional revenue. So far, the authorities have focused their efforts on tax collection, where progress has been achieved by strengthening the tax audit unit, and pursuing more aggressively the non-compliant businesses. Nevertheless, tax non-compliance is estimated to remain high, particularly in the informal sector, and the team urged the authorities to take steps to reduce it. Additional measures should include:

  • Tax administration. The authorities concurred that it is important to eliminate the dual and duplicate efforts by the national and local governments in revenue collection. They also indicated that the imminent adoption of a new customs program should assist in the collection of import duties.

  • Tax policy. The authorities agreed that progress on tax reform had lingered, but indicated that the new government is considering implementing a comprehensive tax reform.8 The mission encouraged the authorities to request technical assistance from PFTAC and study the implementation of tax reform in Federated States of Micronesia.

  • Non-tax revenue. The structure of the fees collected from fishing rights and the ship registration company should be reviewed, to ensure that the government revenue is maximized. The authorities indicated that revenues from the ship registration had recently been increased and that additional revenue from fishing rights would likely be small.

19. There was broad agreement that in addition to fiscal measures, improvements in fiscal management and governance are necessary. To avoid major cash flow problems, the staff encouraged the authorities to utilize the enhanced cash management and commitment control designed by PFTAC. The authorities acknowledged that strict monitoring and expenditure controls are needed but noted that the uptake of the new system had been slow, partly reflecting capacity constraints. There was broad agreement that the government accounts needed to be simplified by reducing the number of separate line ministry funds, which exceed 50. Line ministries should remit fees and charges collected directly to the Ministry of Finance.

20. The financial situation of the local Majuro government is a cause for concern. It is currently in receivership because of a combined debt of $3 million to the national government and the social security administration. This debt has accumulated because of low tax compliance and the lack of effective control over spending.9 Staff urged for a speedy resolution of this issue and greater accountability of the use of funds in the future. The authorities lamented that this is a problem and could take considerable time to resolve.

21. The Compact Trust Fund is an important cornerstone of RMI’s future. The team strongly recommended that prudent management of the CTF in line with international best practices be adopted and that the funds be managed in a transparent manner. The authorities have announced that they are investigating securitizing future trust fund contributions of the United States. The staff cautioned the authorities to weigh carefully the costs and benefits of such a scheme as their calculations indicated the benefits of this may be small and may not justify additional risk (Box 2).

C. Structural Reform

22. The authorities concurred that structural reforms are needed to complement fiscal consolidation to boost private-sector growth. A dynamic private sector is vital to absorb redundant labor from the public sector and ameliorate the impact of declining external support. The mission recommended that the authorities commit to a timeline for implementing various measures to ensure effective monitoring and accountability.

23. Narrowing the wage gap between the public and private sectors would help to create a level playing field for skilled workers, and improve labor mobility. The authorities acknowledged that despite previous efforts to downsize public sector employment, the government continues to be the largest employer. The public-private wage gap remains large, with public sector wages on average almost 50 percent above those in the private sector. The mission suggested that, as a first step, a greater wage differentiation between skill levels could be adopted in the public sector.

24. The difficult business environment has held back growth. According to the World Bank’s 2007 Ease of Doing Business, RMI was ranked lower than all other Pacific island countries, except the Federated States of Micronesia. Key areas of reform include:

  • Land registration. Some progress has been made in registering land, but further efforts need to be placed on strengthening the land registration authority so that applications are not bogged down in the courts. The authorities noted that land ownership issues remain one of the biggest obstacles to foreign investment, and stressed their commitment to continue reform in this area.

  • Investment climate. There are substantial administrative delays and restrictions to foreign investment, including access to land, and limits on foreign workers. The authorities recognized that there was scope for improving business registration and licensing, especially reducing the number of permits and decreasing the time lag for obtaining them.

D. Financial Sector

25. More decisive steps are needed to strengthen the RMI’s financial infrastructure and harness domestic savings for financing growth. The mission encouraged the introduction of measures that would reduce impediments to lending, especially to small private businesses. In particular, the team welcomed the recent adoption of the new legislation on secured lending and supported its rapid implementation, including the establishment of a registry for collateral. Although currently there are no signs of distress in the banking system, the widespread reliance of Marshallese households on high-interest personal credit warrants careful monitoring. The Banking Commissioner agreed that, to safeguard against potential non-performing loans, it will be necessary to ensure that banks are properly classifying problem loans and adequately provisioning against them.

26. Financial sector supervision has been strengthened, but several shortcomings in banks’ operations need to be addressed. The mission endorsed the Banking Commission moves to strengthen the AML/CFT framework.10 Staff also recommended that the Banking Commissioner continues to avoid regulatory changes that would introduce administered interest rates as this could limit banks ability to price credit risk. In addition, the microfinance operation and the non-bank activities of one of the banks need to be closely monitored. The development bank should be placed under the Banking Commission’s jurisdiction and its activities are limited and its accounts audited. Looking forward, additional steps are needed to improve data and information collection, including on loan quality and remittances, and regular reports should be issued. The authorities broadly agreed with the mission’s recommendations.

27. The recent licensing of the third bank is an encouraging development. The arrival of a new bank may help to increase competition in the banking sector and put downward pressure on interest rates. The mission encouraged the authorities to ensure that the new bank operates in a transparent manner, and complies with existing prudential rules and regulations.

E. Other Issues

28. There is an urgent need to improve the reliability, coverage, and timeliness of economic statistics for monitoring and policy evaluation. The mission commended ongoing efforts by the Economic Policy, Planning and Statistics Office (EPPSO), which has a limited number of staff, to improve data collection. Nonetheless, EPPSO could benefit from ongoing and frequent technical support from outside consultants to help not only with the compilation of existing statistics, but also further develop data for the balance of payments and compilation of the fiscal data in Government Financial Statistics format.

29. The RMI is involved in several regional and preferential trade agreements. The mission supported the ongoing discussion with the European Union on a new trade arrangement under the Economic Partnership Agreement. Staff also welcomed the RMI’s involvement in regional fora that promote cooperation among Pacific island countries in areas of common political and economic interest, including the Pacific Agreement on Closer Economic Relations and the Pacific Island Countries Trade Agreement.

IV. Staff Appraisal

30. Achieving economic self-reliance remains the main policy challenge for the RMI, and will require difficult reforms. Given that the Compact grants are decreasing steadily every year, and debt payments will increase substantially in the near future, the current size of the government is not sustainable. Fiscal consolidation and structural reforms are therefore needed, to ensure long-term fiscal sustainability and to boost private sector development.

31. In recent years, the authorities have taken important policy actions to move the RMI toward lasting growth; it is essential to avoid letting this reform momentum stall. Notably, the government has met its mandatory contribution to the Compact Trust Fund, and has successfully reformed its social security administration into a well-performing institution. In addition, the authorities have devoted considerable efforts in improving tax administration. Notwithstanding these commendable achievements, significant challenges remain.

32. To achieve long-term external sustainability, the fiscal position needs to be substantially improved. Staff recommends a fiscal surplus of about 3 percent of GDP in the medium term–a much more ambitious objective than stated in the FY2008 Budget. In order to reach this target, difficult cuts to current expenditure and additional revenue-raising measures will have to be implemented in the near term. The authorities’ intended wage and hiring policy for FY2009 is a solid step toward cutting payroll expenditure. Immediate steps also need to be taken to address the tax non-compliance. The authorities need to avoid slippages in FY2008 and take concrete measures in subsequent years.

33. The Compact Trust Fund is a cornerstone of RMI’s future. Prudent and transparent management of the CTF in line with international best practices should be adopted. In this context, the authorities also need to weigh carefully the costs and benefits of securitizing future U.S. contributions as the benefits of such a scheme may be small and may not justify additional risk.

34. In addition, it will be important to pursue more aggressive structural reforms to energize private-sector activity and employment. The long-term aim is to replace the government as the primary engine of growth. This will require shoring up infrastructure, resolving land issues, and scaling back the government’s commercial activities. Such measures could reduce the cost of doing business, facilitate commercial bank lending, and promote private-sector development.

35. Progress has been made in strengthening financial sector supervision; however, further efforts are needed to ensure that the system performs its role in the development of the economy. There are no signs of distress in the banking system, and the banking commission has made substantial progress in strengthening the AML/CFT framework. Nevertheless, asset quality has to be carefully monitored, as reliance on high-interest consumer loans remains high, and many households are reported to be heavily in debt. The recently adopted legislation on secured lending is an important step in removing obstacles to commercial lending, and should be implemented as quickly as possible.

36. Given the lack of administrative capacity and market structure to have active exchange rate and monetary policies, and the close ties to the United States, dollarization is an appropriate framework for RMI. The authorities successfully maintain an exchange system free of restrictions on international payments and transfers for current transactions.

37. Data provision, while adequate for surveillance, constrains policy evaluation. The authorities willingly share available data, yet deficiencies exist in nearly all areas of economic statistics. Further efforts are needed to build local capacity to produce these statistics.

38. It is recommended that the next Article IV consultation take place on the 24-month cycle.

1

The main factor leading to the difficulty of the energy company was that its long-time supplier discontinued the sale of fuel on a consignment basis, a practice that had been in effect for over a decade. This required the energy company to seek other sources of funding for its fuel inventory. In addition, the energy company was slow to adjust tariffs but has since adopted a template for tariffs that automatically adjusts to changes in world oil prices.

2

Japan Airlines started operating charter flights to the Marshall Islands in early 2007 with six charter flights visiting RMI during 2007.

3

The government has limited access to borrowed funds. In the past, when faced with a cash crunch the Ministry of Finance has either arranged an advance to be taken from the following year’s grant receipts or used grant money as a stopgap measure. The amended Compact does not permit such activities.

4

There is evidence, however, that loans to small businesses are often classified as personal loans to the business owners, to simplify the approval process.

5

Typical interest rates on consumer loans are 18–20 percent, despite the fact that these loans are usually guaranteed by salary allotments, with debt payments deducted from the paycheck by the borrower’s employer.

6

There are no reliable statistics on remittances.

7

Chapter 1 of the Selected Issues describes various scenarios in detail.

8

Chapter 2 of the Selected Issues discusses various options for the tax reform.

9

Unlike the national government, local governments do not conduct tax audits, exacerbating the problem of low compliance.

10

RMI was removed from the FATF list of non-cooperative countries and territories in 2002, and from the OECD tax haven list in 2007.

Republic of the Marshall Islands: 2008 Article IV Consultation: Staff Report; and Public Information Notice on the Executive Board Discussion
Author: International Monetary Fund