Republic of the Marshall Islands
2009 Article IV Consultation: Staff Report; a Public Information Notice; and a Statement by the Executive Director of the Republic of Marshall islands on the Executive Board Discussion.

This 2009 Article IV Consultation highlights that the economy of the Marshall Islands is on a path to recovery. A gradual expansion with growth reaching 0.5 percent in 2010 is supported by further growth in the fish processing industry and additional foreign grant assistance. Rising prices could stoke inflation and stifle domestic demand. Executive Directors have encouraged the authorities to continue to strengthen the statistical base, especially the coverage and timeliness of fiscal and balance of payments data, in order to improve policy analysis and decision-making.

Abstract

This 2009 Article IV Consultation highlights that the economy of the Marshall Islands is on a path to recovery. A gradual expansion with growth reaching 0.5 percent in 2010 is supported by further growth in the fish processing industry and additional foreign grant assistance. Rising prices could stoke inflation and stifle domestic demand. Executive Directors have encouraged the authorities to continue to strengthen the statistical base, especially the coverage and timeliness of fiscal and balance of payments data, in order to improve policy analysis and decision-making.

I. Introduction

1. Large and stable external grants have buttressed economic growth in the Republic of the Marshall Islands (RMI), but access to these foreign funds is time limited. The 2004 Compact of Free Association with the United States (Compact) provides a 20-year stream of funding aimed primarily at education, health, and infrastructure projects. These grants have been a boon to social and economic growth, but come at the expense of fostering economic dependence on foreign income. By 2024, when Compact grants expire, the RMI will have to rely on income from its Compact Trust Fund (CTF), but on current projections, a large revenue shortfall looms.

2. Achieving economic and fiscal self-sufficiency remains a formidable challenge and is exacerbated by a difficult political environment. Like other small Pacific island countries, the Republic of the RMI is vulnerable to external shocks and its remoteness and structural barriers have suppressed the development of a vibrant business sector. The low private sector growth potential and the scheduled phasing out of grant assistance require decisive policy measures to put the economy on a sound footing. Reaching political consensus on key reforms, however, has been challenging. In October 2009, the third government in as many years took office reflecting the difficulties in transitioning from a traditional tribal system to a modern democracy.

3. This year’s discussions focused on policies to secure a sustained recovery and long-term economic and fiscal sustainability. The global crisis has taken a sharp toll on the economy and led to the first recession in 10 years.1 Domestic inflation peaked at 29 percent in the third quarter of 2008 leading to a large decline in real incomes and straining public finances like in many other countries in the region (Figure 1). For policy makers, the crisis was a wake-up call, highlighting the need to modernize the public sector and improve private sector growth and employment prospects. Achieving this goal requires fiscal consolidation, a reform of public enterprises, and structural measures to promote growth.

Figure 1.
Figure 1.

Marshall Islands: Regional Comparison of Recent Developments

Growth contracted in 2008 by more than in other countries in the region, while external and fiscal balances were comparatively unaffected owing to stable Compact related inflows. High commodity prices affected inflation more than elsewhere, but falling commodity prices have eased inflation pressures subsequently.

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Note: RMI and FSM stand for Republic of Marshall Islands and Federated States of Micronesia, respectively.Sources: Fund staff estimates and RMI authorities.

II. Recent Economic Developments

4. Following a contraction in the previous year, the economy stabilized in 2009 (Figure 2). The opening of a fish loining factory and reported increases of remittances provided new impulses to demand. The recovery was also helped by a reversal of the large 2008 terms of trade shock as sharply falling domestic food and energy prices arrested the erosion of household incomes. Inflation declined to 0.5 percent in 2009 after reaching 14.7 percent in 2008.2 These positive growth contributions were, however, largely offset by job losses due to a reduction in personnel at the U.S. military base in Kwajelein and a decline in tourism.

Figure 2.
Figure 2.

Marshall Islands: Macroeconomic Developments

Output contracted for the first time in 10 years in 2008 despite large US compact related transfers, which dominate the current account balance. High food and energy prices led to a spike in consumer price inflation and real income losses. Despite rising spending needs, financing constraints limited the fiscal balance to a small deficit.

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Sources: Fund staff estimates and RMI authorities.1/ Total revenue is sum of grants and domestic revenue (stacked in chart).

5. The fiscal balance remained in deficit in 2009. Staff estimates the deficit at 0.2 percent of GDP, roughly unchanged from 2008. Lack of access to capital markets and limited financial assets provided little room to adjust to the large terms of trade shock. Thanks to additional grants from donors and higher non-tax income from ship registration fees, the government was able to offset lower tax revenue, and to finance tax exemptions granted for imported food and fuel products and higher subsidies to state-owned enterprises (SOEs).

6. The level of public debt remains high, but assets in the Compact Trust and Social Security Funds have begun to recover. Government and government guaranteed debt remained stable at 62 percent of GDP in 2008 and is mostly on concessional terms (40 percent of GDP owed to the Asian Development Bank (AsDB)). The collapse in global equity markets in 2008 led to significant losses for the CTF (-22.6 percent excluding new contributions), but the value of assets recovered to a large degree since then and stands at $97.3 million (63 percent of GDP) at the end of fiscal year 2009. Similarly, the Social Security Fund rebounded to $65.7 million (46 percent of GDP) in 2009, but remained below its 2007 peak.

7. Exports have increased modestly over the last decade held back by structural problems rather than lack of price competitiveness (Figure 3). Similar to other Pacific Island economies, a low inflation rate, closely tracking U.S. consumer price developments, kept the real exchange rate steady.3 The real effective exchange rate appreciated significantly in 2008 with the pass-through of high commodity and food price inflation, but reversed by the second half of 2009. Growth in the tradable sector has been sluggish mainly due to a difficult business environment and remoteness from international markets.4

Figure 3.
Figure 3.

Marshall Islands: Developments in Export Growth and the Exchange Rate 2000–08

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Sources: Fund staff estimates and RMI authorities.

A. Economic Outlook and Risks

8. The mission projected a gradual economic recovery over the near term. Activity in 2010 is forecast to improve moderately to 0.5 percent, supported by a further expansion in the fish processing industry and additional foreign grant assistance (Taiwan, Province of China and the European Union). However, the cresting of Compact grants disbursements, which have supported domestic demand, and structural weaknesses in the private sector will slow the underlying growth momentum. Inflation is projected to rise to 1.5 percent, in line with price developments in the United States given the large share of imported goods in the CPI basket and a projected moderate increase in commodity prices.

9. Risks to the economic outlook are tilted to the downside. The economy’s high import dependence means that fluctuations in commodity prices pose a substantial risk to real incomes. Rising prices could stoke inflation and stifle domestic demand. In the current, weak global economic environment, donor assistance may also be more difficult to secure, posing another downside risk to growth. On the upside, the planned regional collaboration on managing the regional fish-stock (Pacific Nauru Agreement) to capture a higher share of fishing profits by coastal countries could generate a new source of income and growth, but these benefits likely take time to materialize.

10. The authorities agreed with staff’s assessment and emphasized upside risks as growth prospects in the fishing sector had improved. The mission acknowledged these positive risks, but noted that the economy will likely grow more slowly over the medium term compared to previous years. The scheduled annual decline in Compact grant assistance will only be partially offset by income generated from planned expansions in the fish-processing sector and a recovery in tourism. Staff projects that growth will level off at 1.5 percent in the medium term—well below the average rate of 2.7 percent in 2004–07.

III. Policies to Achieve Sustainable Growth

A. Fiscal Adjustment and Public Sector Modernization

11. Achieving long-term budgetary self-reliance and sustained growth have become more challenging after the global crisis. Weakened growth prospects and lower than anticipated CTF asset values imply a projected revenue shortfall—the difference between expiring Compact grants and CTF income—of 9 percent of GDP in 2024 ($16 million in 2009 dollars) (Appendix I). Closing this revenue gap will require a significant adjustment effort to be progressively built over the medium term. The mission assessed that a fiscal surplus of 5 percent of GDP ($9 million) would have to be achieved by 2014 and maintained until 2023 to secure budgetary self-sufficiency.5

uA01fig01

Revenue Gap in 2024

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Source: IMF staff calculation. See Appendix I.

12. The government recognized the need for fiscal adjustment and expressed its intention to target a fiscal surplus in 2010 to increase savings in the CTF. The 2010 budget foresees savings from the elimination of vacant positions and growing revenue from ship registry payments. The mission welcomed these plans, but noted that it would be difficult to achieve a sufficiently large surplus since growing public debt service costs6 (grace periods on concessional loans expire) and more subsidies for the electricity utility will likely more than absorb the savings.

13. The mission noted that comprehensive public sector reform would help achieve fiscal and economic sustainability. Such reforms should be based on three objectives: (i) achieving lasting fiscal surpluses to supplement the CTF; (ii) modernizing the public sector through civil service, tax, and state owned enterprise reform to improve its efficiency and effectiveness; (iii) and providing an enabling environment to develop a growth engine independent from the Compact. The authorities concurred and noted that two reform commissions, the Comprehensive Adjustment Program (CAP) group, tasked with identifying expenditure reforms, and the Tax and Revenue Reform and Modernization Commission (TRRM) had prepared reports on reform plans. Staff recommended that the government transform these initiatives into a comprehensive program.

14. The authorities agreed that both expenditure cuts and revenue gains were necessary to achieve the needed fiscal adjustment. Since revenue measures would take time to prepare and implement, expenditure cuts had to be taken first. In designing its adjustment program, the mission suggested that the government weigh carefully the cost and efficiency implications. The authorities agreed, but cautioned that economic and social implications also had to be assessed carefully.

15. The mission advised the following elements of an expenditure reform strategy:

uA01fig02

Average Public Wage Expenditures (2004-08)

(in percent of GDP)

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Note: The average for Samoa is between 2004 and 2007.Source: Fund Staff estimates.
  • Civil service rationalization. The public sector wage bill has doubled since 2000 primarily due to a rise in the public payroll and, at 22 percent of GDP, is significantly higher than in other countries in the region. The mission welcomed the plan to conduct a comprehensive civil service personnel audit to identify areas of over-staffing and disproportionate pay. Building on the audit’s findings, a combination of civil service pay cuts and reductions in employment should be phased over the near term.

  • Limiting financial support to SOEs. Although the public agency reforms were successful in some cases (for example, the social security administration), many public enterprises continue to be a drain on the budget. Cumulative public support to SOEs through subsidies, net cash advances, and capital injections added up to 18 percent of GDP in the last five years ($27 million), with Marshalls Electrical Company (MEC) and Air Marshall Islands (AMI) being the largest recipients. The mission recommended ceasing general subsidization of energy consumption by raising electricity tariffs to cover production costs and to encourage conservation. Import duty exemptions to the MEC should be reversed, and public financial support through the granting of advances for future electricity services should be made explicit in the budget.

  • Cutting other expenditures. Allowances to civil servants and public officials (such as housing and electricity) come at a large annual cost to the budget (1.2 percent of GDP) and are not well targeted. The mission supported the CAP’s recommendation to minimize these allowances, which would reduce the operational losses of the electricity utility.

uA01fig03

Financial Support of State Owned Enterprises: 2004–08

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

Source: RMI audit reports. Data for MISC are only available for 2007 and 2008.

16. The authorities agreed with the priorities for expenditure cuts, but argued that reductions of the public work force could have a broad economic and social impact. Reducing public sector employment could deprive large family-groups of income given that the private sector was unlikely to absorb any shed labor and the absence of a social safety net. Instead, the authorities preferred reductions in hours-worked and enforcement of mandatory retirement rules. Staff recognized these challenges, but noted that a shift to part-time employment risked a policy reversal and preserved the large public-private sector wage differential, which was crowding out private employment.

17. On revenue measures, the mission supported the authorities’ plan to modernize the tax system. The existing tax system lacks the ability to raise additional revenue, fails to encourage private investment, and is inequitable. The gross revenue tax (GRT) has a cascading effect, and the proliferation of small taxes has complicated tax administration. Finally, many sources of income are exempt generating inequity. On this basis, the mission recommended:

  • Adoption of a comprehensive tax reform program. The mission recommended that the TRRM Commission’s proposal be based on a PFTAC developed tax reform plan (Box 1). The plan should be accepted as a uniform package of measures and tax rates and registration levels set in order to generate additional revenue. Given the amount of preparatory work and time required for implementation (up to 36 months), the mission recommended priority be given to drafting the needed legislation.

  • Unification of tax administration. The mission noted that while tax enforcement had been stepped up, administrative capabilities needed to be strengthened. Improved audit activities at the social security administration had already led to a sizeable reduction in unpaid contributions and improved compliance. Since there are significant gains to be made from harmonizing collection processes and information sharing, the mission advised the establishment of a unified revenue administration as part of the tax reform.

Tax Policy Modernization: Current System and Reform Options

Relative to the size of the fiscal adjustment over the medium term, the current tax system is unlikely to generate additional revenue. The annual revenue yield of 18 percent of GDP is below those in other economies, which have introduced tax regimes based on international practice (26 percent of GDP in Samoa and Tonga in 2007). The low yield potential is the result of an outdated tax system and low compliance (see IMF 2008 Selected Issues).

PFTAC has proposed a reform strategy centered around four basic changes aimed at raising efficiency, removing distortions, and increasing revenue while attempting to keep tax rates low.

  • (1) Replacing the GRT and a number of specific business taxes and duties with a broad based consumption tax, to eliminate cascading, strengthen compliance, and simplify the tax system;

  • (2) Introducing a net profit tax for large businesses while retaining the GRT for small businesses. The net profit tax would eliminate tax cascading, remove disincentives for investment, and lead to more equal taxation across different types of businesses; only the largest 25 percent of businesses would fall under the new net-profit tax;

  • (3) Replacing the existing import duties and local government taxes on alcohol, tobacco, motor vehicles and fuel with similar excises, which would make them acceptable revenue sources for regional trade agreements; and

  • (4) Modifying the wages and salaries tax by broadening the tax base to include items, which are currently exempt, modifying and expanding the current tax-free threshold so that it is available to all taxpayers, and introducing a higher tax rate for high income earners.

The economic impact of the new tax system on growth would likely be small, as efficiency gains outweigh negative growth effects. Successful reform examples of consumption tax reform include Fiji and Samoa, and more recently Tonga. Preliminary estimates for the RMI point to a positive revenue impact of between $2 and $8 million (1.4–5.5 percent of GDP) in the medium term, depending on the level of statutory rates for consumption and net profit taxes and chosen registration threshold levels.

18. The mission cautioned that unfunded liabilities of the social security system were a sizeable contingent liability. The 2009 actuarial report identified $180 million of unfunded liabilities (120 percent of GDP). In past years, rising benefit payments have been covered by aggressively pursuing accounts receivables and by drawing on investment income. Rapidly rising benefits will, however, begin to erode fund assets in the near term. In light of the worsening financial situation, the mission recommended that the authorities consider an adjustment plan featuring various possible options. The authorities noted that they were exploring future funding options including a reduction in benefits, increase of contribution rates, and a transition to a defined contribution system.

19. The government welcomed the idea to use its recent SDR allocation for precautionary purposes. Large swings in commodity prices and the impact of climate change (for example flooding) are likely to increase the demand for short-term fiscal support. The mission suggested that the government reserve the RMI’s recent SDR allocation—an unconditional credit line from the IMF of about $6 million (3 percent of GDP)—for precautionary purposes. The authorities agreed and planned to explore how the terms of its use could be formally regulated.

20. The mission urged the authorities to carry out public expenditure management reforms. The government has taken steps in improving expenditure management since the amended Compact, but cash management is still based on cash rationing. The mission recommended to implement a new commitment control based management system developed with PFTAC assistance. The authorities agreed and noted that the government had scaled up its performance budgeting efforts. The mission encouraged the Ministry of Finance to become part of the exercise to strengthen its role in holding line Ministries accountable for an efficient and effective use of public funds.

B. Structural Reforms to Enable Growth

21. A vibrant private sector would contribute to economic and fiscal sustainability. The domestic economy currently depends heavily on income generated from the Compact through the consumption of goods and services, public wages, and construction projects. A larger self-sustaining business sector independent from the Compact would provide an important alternative source of income and employment. Job creation is particularly important in light of the high structural unemployment rate estimated at 30 percent.

22. The mission stressed that the government’s role in supporting private sector growth should be geared towards providing an enabling environment. To support the private sector, the mission recommended the authorities focus on developing efficient infrastructure services, strengthening education and training of the workforce, and improving access to secured commercial lending. In particular, the lack of reliable electric services and the high cost of telecommunications were important obstacles to private sector development.

23. To improve the performance of SOEs, the mission suggested that a more transparent delineation between commercial and non-commercial services could help. Many SOEs have community service obligations, such as providing transportation or utility services to remote parts at below cost recovery tariffs. These mandates are, however, often not clearly defined and typically subsumed in the SOE’s overall operating activities through cross-subsidization. This lack of transparency complicates resource planning and has contributed to weak management, underinvestment, and a continued need for subsidies and capital injections. As a result, bottlenecks in electricity provision and high costs of telecommunications, which are magnified by a small market and a high debt burden, have raised the cost of doing business and limited the development in the outer islands (for example, by limiting access to electricity or mobile banking). The mission recommended that the authorities explore the use of contractual arrangements in the form of community service obligations, which have been successful elements in the reform of SOEs in other countries (for example Fiji shipping company).7

24. In areas where SOEs provide purely commercial services, the mission recommended divestment. The authorities reported that they already planned to sell their stake in a hotel and were in discussions to change the public ownership of the domestic airline (AMI). Financial audit reports indicated that under current arrangements, AMI was unlikely to deliver on its community service obligations, and the mission suggested that the government should consider downsizing and divestment. The mission also recommended contracting out the management of the government’s copra processing plant (Tobolar) through a competitive and transparent process.

25. The mission and the authorities agreed that the business environment remains challenging. To facilitate mortgage and commercial lending, the mission encouraged the government to step up efforts to facilitate land registration. The authorities noted that a new act on secured transactions for moveable property is now being implemented and should strengthen access to commercial credit at reduced interest costs.

C. External Stability and Exchange Rate

26. The authorities and staff agreed that risks to external stability were limited and the use of the U.S. dollar as currency remained appropriate given the size and remoteness of the economy. Compact related financial flows dominate external balances and result in a large current account deficit (8 percent of GDP in 2009). Staff and authorities agreed that the Compact would continue to provide a stable source of funding over the next decade, but increased debt repayment on foreign loans to the public sector (1.5 percent of GDP) would create some pressure. In the long run, the expiration of the Compact could lead to an erosion of foreign assets undermining external stability unless needed fiscal adjustments are carried out.

27. There appears to be no evidence of a price competitiveness problem (Figure 3). The 7 percent real appreciation in 2008 was largely reversed in the second half of 2009 as domestic prices, in particular for food, fell faster than in the U.S., its main trading partner. The authorities underscored that exports as a percentage of GDP had risen over the last decade, while they declined in most other Pacific island economies (Figure 3).

D. Financial Sector

28. The banking system remained profitable, but contributes little to economic growth. The banking system comprises two private banks and a public development bank, which operates outside the regulatory framework. The banking sector is primarily financed by deposits of which 65 percent is used for domestic lending. Claims on the private sector reached about 40 percent of GDP in 2009, but were largely directed towards consumer loans. Domestic investment in fixed and mobile capital remains suppressed, owing to a lack of collateral (unresolved land ownership) and poor business management. Bank profits have been solid during the last years (4.5 percent RoA) on the back of large lending spreads.

29. The mission advised the Banking Commission to take steps to limit consumer borrowing given high household indebtedness (Table 4). Consumer lending represents 75 percent of private sector lending and average household indebtedness on consumer lending is estimated at 50 percent of labor income. The mission noted the potential risks of a high debt burden to the banking system, but acknowledged that the share of non-performing loans (excluding the public bank) remained at a very low level in 2009. However, with no prudential limits on consumer borrowing, the mission supported the Commissioner’s plans to modernize the Banking Act. They also encouraged the supervisor to continue strengthening monitoring capabilities, improve data collection, especially on remittances, and issue regular reports.

30. The mission urged the authorities to place the development bank under the Banking Commission’s jurisdiction and end its unsecured consumer lending operations. The development bank holds 13 percent of overall banking sector assets and is heavily engaged in unsecured consumer lending. These activities are not monitored or regulated by the Banking Commission and the mission was unable to assess the quality of its loan book. The mission recommended that the bank cease lending for consumption purposes and focus instead on investment projects that face structural constraints, such as lack of collateral from unavailable land ownership titles. The Banking Commissioner agreed that the current lending practices pose a risk to the development’s bank’s capital base and to the government as its sole owner and that enhanced monitoring was necessary.

IV. Staff Appraisal

31. Achieving long-term budgetary self-reliance and sustained economic growth have become more challenging after the global crisis. Access to stable Compact grants helped advance economic development and supported a large public sector. But a recession in 2008 and falls in the value of the CTF (as a result of the global equity slump) have dimmed prospects of achieving fiscal sustainability. The scheduled decline of Compact grants and the need to replenish the CTF require a large fiscal adjustment.

32. The authorities recognize the need for reform and are looking to transform existing proposals into an actionable comprehensive adjustment program. Two local reform commissions tasked with identifying expenditure and revenue reform proposed far-reaching changes in expenditure and tax policies. These need to be unified into a comprehensive medium-term reform program aimed at achieving lasting fiscal surpluses by streamlining the public sector and implementing a broad based tax policy reform; creating more efficient SOEs; and establishing a more business friendly environment.

33. Securing fiscal sustainability requires a strategy that phases in spending cuts while launching a comprehensive tax reform. Consolidation needs to begin with cuts to the large public wage bill, an elimination of electricity and housing allowances, and the adjustment of electricity tariffs to cost-recovery levels. Tax reform should be comprehensive and include the replacement of the GRT with a net profit tax, the introduction of a consumption tax, an income tax reform, and a unification of tax administrations. In combination, expenditure and revenue measures should achieve a fiscal surplus of 5 percent of GDP in the medium term to secure budgetary self-sufficiency once the Compact expires.

34. Structural reforms need to be stepped up to attain a growth path consistent with domestic and external stability. As Compact grants decline, the economy needs to rely more on a self-propelled private sector. The government’s role is to establish an enabling environment. An important priority is SOE reform to supply more reliable and cost-efficient infrastructure services, especially in the electricity and telecommunication sectors. In other areas, where SOEs conduct commercial activities, the government should divest or scale back its operations.

35. The banking sector should contribute more effectively to economic development while household indebtedness needs to be monitored. Banks primarily lend to consumers with little impact on economic development. High household indebtedness and the absence of regulatory oversight by the Banking Commission over the development bank are risks to the banking system, although commercial banks appear to be financially sound. A new secured lending act for mobile assets should facilitate commercial lending, but further efforts are needed to increase the use of land as collateral through land registration. The public development bank should be brought under the supervision of the Banking Commission. Efforts to strengthen banking supervision through improved monitoring capabilities, data collection, and increased reporting are welcome.

36. The U.S. dollar is the appropriate currency for the RMI, given the size of the economy, its close ties to the United States, and limited administrative capacity for independent monetary and exchange rate policies.

37. The quality of official statistics, while adequate for surveillance, should be strengthened. Data provision has improved, but limited coverage and timeliness of economic and social statistics constrain policy evaluation. Continued staff training and a new national census would aid policy planning.

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

Table 1.

Marshall Islands: Basic Data, FY2004–10 1/

article image
Sources: Data provided by the Marshallese authorities; and IMF staff estimates.

Fiscal year ending September 30 unless otherwise stated.

2009 data are the average of three quarters.

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

Includes government and government-guaranteed debts.

Table 2.

Marshall Islands: Central Government Finances, FY2004–10 1/

article image
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.

In FY2008, cash advance to the energy utility of US$6.75 million is recorded as subsidy, and electricity consumption of US$0.76 is deducted from goods and services.

For FY05-06, capital expenditure includes additional capital projects financed by Taiwan POC and U.S. grants for the airport.

Excluding Compact Trust Fund.

Central government debt to ADB.

Table 3.

Marshall Islands: Balance of Payments, FY2004–10 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.

Table 4.

Marshall Islands: External Vulnerability Indicators, FY2004–10

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

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

2009 is average of three quarters.

Defined as loans with arrears in excess of 90 days. 2009 is average of three quarters.

Table 5.

Marshall Islands: Medium-term Scenario, FY2006–14 1/

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

Fiscal year ending September 30.

In FY2008, cash advance to the energy utility of US$6.75 million is recorded as subsidy and electricity consumption of US$0.76 is deducted from goods and services.

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

Government and government-guaranteed debt only.

Appendix: Marshall Islands—Long-term Fiscal Sustainability

1. After the completion of the first Compact, the RMI signed an amended Compact agreement in 2004 with a 20-year tune horizon. The amended Compact introduced a new fiscal framework by creating a Compact Trust Fund (CTF) and by earmarking grants to specific sectors (infrastructure 30–50 percent; remainder for education, health care, environment, capacity building, and private sector development). The main purpose of the trust fund is to create an income stream to replace the Compact grants after 2023, when the agreement expires.

2. This note updates the IMF’s long-term fiscal projections as developed in 2008 IMF Selected Issues paper and assesses the implications of the 2008 global equity market corrections and of the delays in fiscal adjustment. The note defines fiscal sustainability as an 2023 CTF asset level that would create an income stream large enough to replace the Compact grants without eroding the real value of the assets, as required under the Trust Fund agreement.

3. Under the baseline scenario, the CTF’s income balance would not be large enough to cover Compact grants in 2024. This scenario assumes that the government maintains a fiscal surplus of about 1½ percent of GDP throughout mainly to service public debt repayment obligations. GDP growth gradually decelerates to 1.2 percent as foreign grant assistance declines while private sector growth remains sluggish, and declines to 0.5 percent after the Compact agreement expires. The rate of return on CTF assets in 2009 is estimated to be about 9.4 percent and projected to stay at about this level in 2010 and decline to 6 percent thereafter. Compact grants are projected to reach $45.3 million in 2023. Given the terms of the Compact agreement and without additional contributions, the fund’s investment earnings are projected to be $37 million in 2024. In order to preserve the real value of the fund, the RMI government would only be able to withdraw $23.3 million, leaving a gap of US$22 million ($10.5 percent of GDP see text table). Therefore, in the baseline scenario, the RMI government either would need to erode the real value of the CTF or would face a large budgetary shortfall.

Marshall Islands Compact Trust Fund (CTF): Baseline Versus the Policy Action Scenario

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

Source: IMF staff calculations.
uA01fig04

Marshall Islands: Long-Term Fiscal Adjustment Scenarios: FY2009–301

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 051; 10.5089/9781451825954.002.A001

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

4. While higher returns can help achieve fiscal sustainability, obtaining such high returns over the entire period is not realistic. The baseline assumes a relatively conservative investment strategy with average nominal rate of return of 6 percent. Higher returns would be possible with a more aggressive investment strategy, albeit at the cost of higher risks. For example, if the average rate of return were 8.2 percent, the shortfall would be eliminated. This rate of return is 0.2 percentage point higher than the equivalent estimate from the 2008 Article IV consultation.

5. Fiscal sustainability can be achieved through significant fiscal consolidation and structural reforms to boost private sector growth. In an alternative policy scenario, the government would gradually shift public finances into surplus (by about one percent of GDP each year) and channel the generated savings into the CTF. Over the medium-term, roughly half of the adjustment would come from tax revenues and the other half from reductions in current expenditures. In parallel, structural reforms are assumed to boost real growth to 2 percent. This scenario continues to assume a nominal rate of return to the CTF of 6 percent. With these assumptions, fiscal sustainability would be achieved by progressively building a fiscal surplus to reach around 5 percent of GDP in 2014. The surplus would stay at this level until 2024 then decline to about 1 percent. Together with the additional earnings resulting from higher balances, the fiscal surplus would eliminate the revenue shortfall (see text table). The required adjustment in the 2008 IMF Selected Issues paper was less, at about 3.5 percent of GDP. The difference mainly reflects the significant declines in the value of CTF assets during 2008.

6. With fiscal consolidation, the government would be able to obtain a constant revenue stream to finance its expenditures. In particular, under the alternative policy scenario, the government keeps capital spending constant throughout. However, current expenditures would be adjusted so that total revenues could both finance total expenditures and generate a sustainable assets level in the CTF. The reduction in the fiscal surplus in 2024 would not constitute a fiscal stimulus. Rather it would reflect the switch from a grant to a CTF income based funding system, as foreseen under the Compact. In 2024, there is no need to save additional amounts to accumulate the CTF, total revenues including interest income obtained from the CTF, are only used to finance overall yearly budget expenditures eliminating the need for continued surpluses.1

1

Annual data refer to the fiscal year ending in September.

2

Almost all of the increase was driven by food, utilities, and transport price increases, reflecting changes in world commodity prices.

3

The U.S. dollar is the official currency.

4

The recent decline in tourism, for instance, was related to unreliable domestic air transportation services by the state-owned airline.

5

By putting the savings into the CTF, projected income would be large enough to offset the revenue shortfall from expiring grants, while preserving the asset base in the CTF.

6

Amortization payments on central government debt to AsDB are estimated to grow to 1.2 percent of GDP over the medium-term.

7

The Fiji government competitively tenders for subsidized shipping services, with private companies providing services at lower-cost to the government.

1

After 2024, the government still runs an overall surplus to service external debt.

Republic of the Marshall Islands: 2009 Article IV Consultation: Staff Report; a Public Information Notice; and a Statement by the Executive Director of the Republic of Marshall islands on the Executive Board Discussion.
Author: International Monetary Fund
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    Marshall Islands: Regional Comparison of Recent Developments

    Growth contracted in 2008 by more than in other countries in the region, while external and fiscal balances were comparatively unaffected owing to stable Compact related inflows. High commodity prices affected inflation more than elsewhere, but falling commodity prices have eased inflation pressures subsequently.

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    Marshall Islands: Macroeconomic Developments

    Output contracted for the first time in 10 years in 2008 despite large US compact related transfers, which dominate the current account balance. High food and energy prices led to a spike in consumer price inflation and real income losses. Despite rising spending needs, financing constraints limited the fiscal balance to a small deficit.

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    Marshall Islands: Developments in Export Growth and the Exchange Rate 2000–08

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    Revenue Gap in 2024

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    Average Public Wage Expenditures (2004-08)

    (in percent of GDP)

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    Financial Support of State Owned Enterprises: 2004–08

    (In millions of U.S. dollars)

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    Marshall Islands: Long-Term Fiscal Adjustment Scenarios: FY2009–301

    (In percent of GDP)