Federated States of Micronesia: Staff Report for the 2010 Article IV Consultation—Informational Annex

The economy has recovered following the stabilization of commodity and food prices. The Article IV discussions focused on policies to secure a sustained recovery and achieve long-term economic and fiscal sustainability. The recovery will likely remain weak, and the consolidated fiscal surplus is expected to decline in the near term. Long-term sustainability could be achieved through increasing the fiscal surplus. The reliability, coverage, and timeliness of economic statistics need to be improved to guide policies. The global crisis has increased the urgency of major fiscal and structural reforms.

Abstract

The economy has recovered following the stabilization of commodity and food prices. The Article IV discussions focused on policies to secure a sustained recovery and achieve long-term economic and fiscal sustainability. The recovery will likely remain weak, and the consolidated fiscal surplus is expected to decline in the near term. Long-term sustainability could be achieved through increasing the fiscal surplus. The reliability, coverage, and timeliness of economic statistics need to be improved to guide policies. The global crisis has increased the urgency of major fiscal and structural reforms.

Annex I. Federated States of Micronesia: Fund Relations

(As of November 30, 2010)

I. Membership Status: Joined June 24, 1993; accepted Article VIII.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None.

V. Financial Arrangements: None.

VI. Projected Obligations to Fund: None.

VII. Exchange Rate Arrangement:

The U.S. dollar is legal tender and the official currency. The Federated States of Micronesia (FSM) maintains an exchange system that is free of restrictions on international payments and transfers for current and capital transactions except for security reasons.

VIII. Article IV Consultation:

The FSM is on the 24-month consultation cycle. The 2008 Article IV consultation discussions took place during November 12-21, 2008. The Executive Board discussed the staff report (Country Report No. 09/81) and concluded the consultation on February 25, 2009.

IX. Technical Assistance, 1999–2010:

STA, MCM, LEG, and PFTAC have provided technical assistance on statistics, banking supervision, tax policy, and combating of financial crime and financial system abuse.

X. Resident Representative: Mr. Yongzheng Yang assumed his duties as the Resident Representative for Pacific Island Countries on September 13, 2010. He is based in Suva, Fiji.

Annex II. Federated States of Micronesia—Relations with the Pacific Financial Technical Assistance Center (PFTAC)8

Since 2000, the Center’s assistance to the FSM has included 30 advisory missions, mostly in the areas of tax policy and administration, financial sector supervision, and statistics. The FSM has also sent a number of officials to various regional seminars and workshops organized by PFTAC.

Tax Administration and Policy

PFTAC designed a comprehensive tax reform program to help FSM improve the effectiveness of its tax regime and raise additional revenue. In 2005, the President approved recommendations of the Tax Reform Task Force and established an Executive Steering Committee to manage the reform process. The FSM authorities are currently discussing the legislation drafts prepared by IMF Legal Department. PFTAC has provided assistance in revenue estimation, communications and IT strategies, and continues to provide assistance on tax administration improvements and project management.

PFTAC has also participated in customs modernization program including development and implementation of the PC Trade computer software system and provided related TA to facilitate trade, speed up clearances, and improve data accuracy.

Financial Sector Regulation and Supervision

In May 2006, a PFTAC advisor visited FSM to review draft insurance legislation. An aide memoire was provided to authorities on the supervision of insurance in FSM. The mission discussed and reviewed the proposed insurance legislation and followed up on aspects of issues identified in an IMF technical assistance (TA) mission in March 2006. The Commissioner was cognizant of the need to establish a legislative and supervisory framework for insurers, domestic and foreign, which are active in FSM. Subsequently, a peripatetic expert was assigned by the Monetary and Capital Markets Department (MCM) to the FSM to provide assistance to the Commissioner in insurance regulation and supervision. In addition to the peripatetic advisor on insurance regulation and supervision, the PFTAC advisor also visited the FSM in April 2008. The PFTAC advisor provided assistance to the Commissioner in a number of areas, including drafting proposed regulations for the supervision of captive insurance companies, reviewing and making recommendations regarding applications submitted by a foreign bank to expand the number of branch offices in the FSM, and providing training in off-site bank supervision to Commissioner’s staff. In September 2010, the PFTAC advisor provided assistance and training to Banking Board staff in conducting an on-site bank examination. Assistance activities included providing guidance and training the completion of examination procedures for assessing the adequacy of branch liquidity policies, verifying the accuracy of prudential returns, assessing the adequacy of the compliance with AML laws and policies, and credit risk practices. Guidance was also provided to the supervision staff in the preparation of appropriate comments documenting apparent violations of laws and regulations. The PFTAC advisor continues to liaise closely with the authorities as needed.

Economic and Financial Statistics

A workshop on National Accounts was conducted in October 2006 by the PFTAC Statistics Advisor and an expert. Wider macroeconomic statistics issues were also covered briefly, and an outreach program involving education of officials in the four state governments of the importance and uses of macroeconomic statistics was conducted.

The PFTAC Statistics Advisor undertook a TA mission to Pohnpei during October 2008 to improve the national accounts statistics. During the mission, the advisor completed a review of the latest current and constant price GDP estimates. A number of improvements were proposed, including in the coverage of the informal sector and subsistence activities and use of more appropriate price deflators and volume indicators. In addition, a number of recommendations were made to further strengthen the national accounts methodology and source data. The mission concluded that at this stage, producing estimates of GDP using production and expenditure approaches as well as gross value added (GVA) by industry is not feasible due to source data limitations. On-the-job training in compilation of GDP using the income method was also provided as part of the review process of data sources and compilation spreadsheets.

An expert provided by PFTAC undertook a TA mission during May 2009 to improve the balance of payments statistics. The mission reviewed source data, methodology and processes and made a number of recommendations for improvement. On-job training was provided.

FSM participated in a regional national accounts training seminar conducted in Fiji in July 2009 and a regional BOP course in Fiji from November to December 2010.

Annex III. Federated States of Micronesia—Relations with the Asian Development Bank (AsDB)1

The Federated States of Micronesia (FSM) became a member of the AsDB in 1990, and has received a substantial amount of assistance since that time. As at December 2009, the FSM has received eight loans, 1 grant, and 43 TA grants.2

The AsDB has assisted the FSM by (i) supporting good governance, with a particular focus on economic management and accountability; (ii) ensuring inclusive social development; and (iii) promoting sustained private sector-led economic growth. The approach of the ADB has been to focus on a few key constraints: careful analysis of the political economy; a preparedness to closely manage and support operations; a move away from complex federally administered and state delivered multistate and multisector projects; adoption of home grown solutions; and simple and realistic project outcomes.

Under AsDB’s country operations business plan for 2011-13 special attention will be given to supporting infrastructure development, especially power sector development and transport. Support to the energy sector will reduce heavy reliance on fossil fuels, through renewable energy in the form of hydropower, solar energy, and wind energy. Emphasis will be placed on the need for institutional and tariff reform supported by full cost recovery at Utility and State level.

Currently there are two active loans. The Omnibus Infrastructure Development project loans (totaling $19m), approved in 2004, are designed to enhance public health, environmental quality, and surface water quality through improved wastewater infrastructure and management for Pohnpei and improved delivery of water services and expanded water supply systems for Yap and Kosrae; and improved management and provision of power in Chuuk.

AsDB’s non-lending program has focused on improving public sector efficiency, effectiveness, and accountability, as well as raising public awareness through community consultation and participation programs, particularly in Chuuk and Kosrae. Further Technical assistance will be provided to provide for capacity building in project management and procurement processes to support infrastructure development.

Table 1.

Loans to the Federated States of Micronesia by Sector

(In millions of U.S. dollars; as of December 2009)

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Table 2.

Loan Approvals and Disbursements to the FSM, 2000–09

(In millions of U.S. dollars)

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Annex IV: Bank-Fund Collaboration

37. The Bank and the Fund country teams maintain a close working relationship and have an ongoing dialogue on a range of macroeconomic and structural issues.

38. The teams agreed that FSM’s main macroeconomic challenges are to reduce its high dependency on the Compact support from the U.S., which is due to expire in FY2023, while enhancing the prospects for private sector development. To achieve these goals, FSM needs to undertake a decisive fiscal reform as well as to improve business environment.

39. Based on this shared assessment, the teams identified the following structural reform areas as macro-critical, in view of their central role in achieving fiscal consolidation and sustained growth:

  • (i) Comprehensive revenue reform. FSM collects little revenue from its income and sales taxes, compared with other Pacific Island countries. The government’s tax reform package, which includes the introduction of VAT and the net pr ofits tax, and establishment of the Unified Revenue Authority (URA), is yet to pass the Congress, behind the schedule by more than 1 year. The successful tax reform would also benefit the private sector by improving efficiency.
  • (ii) Reform of the state-owned enterprises (SOEs). SOEs put a significant burden on FSM’s budget, while possibly crowding out private firms. They pay higher wages than in the private sector, receive subsidized government loans, and are not subject to the gross revenue tax. The government has taken some steps, including the shutdown of insolvent enterprises such as the National Fisheries Corporation, but more needs to be done.
  • (iii) Financial sector reform. Commercial banks are reluctant to lend to local businesses despite their ample liquidity. Part of the reason is the inherent risk of start-up lending, the high fixed costs associated with small loans, and the difficulties in collecting on collateral. Moreover, the FSM Development Bank continues to lend to well-established firms rather than supporting start-ups. To improve access to credit, it is necessary to redirect the focus of the FSM Development Bank, expand micro-credit through credit unions and micro-credit agencies, and improve the functioning of the secured transaction framework.
  • (iv) Reform of the statistical system. Limited domestic capacity to produce economic data prevents understanding of the contribution to the economy of sectors as tourism, fisheries and agriculture, making difficult timely policy response to any shocks to those sectors. Strengthening the statistical capacity is macro-critical, because timely and reliable provision of data is required to assess the economic conditions appropriately and to make necessary policy decisions accordingly.

40. The teams agreed to continue the close cooperation going forward. Appendix I details the specific activities planned by the two country teams over the period September 2010 – August 2011 along with their expected deliveries. The Bank is currently in the process of reclassifying FSM from an IBRD to an IDA-eligible country. This reclassification will have implications for the Bank’s potential lending program and the relevant outcomes of discussions with the government will be shared with the Fund team.

Bank and Fund Planned Activities in Macro-Critical Structural Reform Areas

(September 2010–August 2011)

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ANnex V. Micronesia—Statistical Issues

As of December 13, 2010, 2010

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Micronesia: Table of Common Indicators Required for Surveillance

As of December 13, 2010

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Any reserve assets that are pledged of otherwise encumbered should be specified separately. Also, data should comprise short-term liabilities linked to a foreign currency but settled by other means as well as the notional values of financial derivatives to pay and to receive foreign currency, including those linked to a foreign currency but settled by other means.

Include the interest rates on consumer loans and commercial loans. Deposit rates are received annually with latest observation for 2009.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Includes external gross financial asset and liability positions vis-à-vis nonresidents.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA)

8

The Pacific Financial Technical Assistance Center (PFTAC) in Suva, Fiji is a multi-donor technical assistance institution, financed by IMF, AsDB, AusAID and NZAID, with the IMF as Executing Agency. The Centre’s aim is to build skills and institutional capacity for sustained economic development. Member countries are: Cook Islands, Federated States of Micronesia, Fiji, Kiribati, Marshall Islands, Nauru, Niue, Palau, Papua New Guinea, Samoa, Solomon Islands, Tokelau, Tonga, Tuvalu, and Vanuatu. This annex is prepared on the basis of the input from the PFTAC staff.

1

Prepared on the basis of information from AsDB staff.

2

The eight loans are for: (i) fisheries development; (ii) law, economic management and public policy; (ii) water supply and sanitation; (iv) basic social services; and (v) private sector development. No loans to FSM in 2008-2010.