Appendix I. Micronesia—Medium-Term Fiscal Outlook
This appendix updates previous staff work on the size of the needed fiscal adjustment to achieve self-sufficiency after the end of the Compact in FY2023. The appendix describes the results of medium-term simulations under three scenarios: (i) a baseline with limited fiscal adjustment and structural reforms, (ii) a scenario with comprehensive fiscal and structural reforms, and (iii) a reform, but under more adverse financial market conditions. The results indicate that structural reforms and fiscal adjustment are crucial for raising growth prospects and ensuring that the government has sufficient savings to offset the end of Compact grants in FY2023.
The FSM (with a population of about 108,000) has four states—Chuuk, Kosrae, Pohnpei, and Yap, each with its own executive and legislative bodies. Authority is highly decentralized, with state governments significantly larger than the national authority.
The fiscal year runs from October to September (for example, FY2008 covers October 2007 to September 2008).
A recent PFTAC mission concluded that the existing national accounts statistics may have underestimated GDP growth in recent years. However, the preliminary revised estimates still point to a stagnating economy.
The large current account deficit has been largely financed by capital transfers related to the Compact and unrecorded remittances.
Some doubts remain over the reliability of official CPI statistics as the food and fuel-related items account for over half of the CPI basket.
The share of tax revenue in GDP in the FSM fell by about 1 percentage point between FY2006–08.
The required budget surplus varies by state given the different starting level of savings, but even Yap—the state with relatively high savings—will need to improve its fiscal position.
On current trends, the national government and Pohnpei would run out of cash in two years. Chuuk and Kosrae continue to be in arrears. The implications of the ongoing financial turmoil for government finances are discussed in more detail in Appendix I.
Yap’s fiscal deficit increased from $2.3 million to estimated $4.1million (10 percent of state GDP) during FY2006–08.
Tax revenue in the FSM account for only 12 percent of GDP, compared with more than 20 percent of GDP in many other Pacific Island countries, such as Kiribati, Palau, Samoa, and Tonga.
For example, there is anecdotal evidence that companies are delaying investment over uncertainty regarding the introduction of the net profit tax, which will allow them to deduct investment expenses from the tax base.
Many FSM institutions recorded losses on their overseas investments over the past year, for example, the Compact Trust Fund lost about 20 percent of its value during FY2008. However, the national authorities noted the losses of the Social Security Fund were larger than the relevant benchmarks due to the inexperienced investment board.
For example, a state investing $30 million with management fees that are higher by 0.5 percent annually could under plausible assumptions pay $4.3 million in additional fees and lost returns by FY2023.
Government Accountability Office, 2007, “Compact of Free Association: Trust Funds for Micronesia and the Marshall Islands May Not Provide Sustainable Income,” Report to Congressional Committees.
The assumed 2¾ percent GDP growth rate is not unprecedented in the FSM as Yap reached similar growth during the first Compact period. Compared with the 2006 Article IV Consultation (Country Report No. 07/106), the estimated target medium-term surplus has slightly increased (by about ¼ percentage point of GDP) as a result of the greater-than-expected FY2006 fiscal deficit, recent increase in subsidies, and one-year delay of the tax reform. These factors, however, have to some degree been offset by strong investment returns during FY2006–07, fiscal consolidation in Chuuk and Kosrae, donor assistance, and the partial write-off of arrears in Chuuk.
See the IMF Selected Issues Papers on the Republic of Marshall Islands (Country Report No. 07/105).