Republic of the Marshall Islands: Staff Report for the 2013 Article IV Consultation

This 2013 Article IV Consultation highlights that the GDP growth of The Republic of the Marshall Islands (RMI) picked up in FY2012 (fiscal year, ending September 30) to 3.2 percent, lifted by a surge in fishery output and higher copra and coconut oil production. In FY2013, however, growth is expected to have slowed to 0.8 percent, dragged down by delays in the implementation of infrastructure projects. The current account deficit including official transfers remained elevated at 8.1 percent of GDP in FY2012. In FY2014, GDP growth is projected to rebound to 3.2 percent, driven by the resumption of Compact-funded infrastructure projects.

Abstract

This 2013 Article IV Consultation highlights that the GDP growth of The Republic of the Marshall Islands (RMI) picked up in FY2012 (fiscal year, ending September 30) to 3.2 percent, lifted by a surge in fishery output and higher copra and coconut oil production. In FY2013, however, growth is expected to have slowed to 0.8 percent, dragged down by delays in the implementation of infrastructure projects. The current account deficit including official transfers remained elevated at 8.1 percent of GDP in FY2012. In FY2014, GDP growth is projected to rebound to 3.2 percent, driven by the resumption of Compact-funded infrastructure projects.

Background

1. The RMI is a small and isolated country, with a dispersed population and limited export base, highly dependent on external aid and vulnerable to climate change. Under the renewed Compact Agreement with the US, the RMI will continue to receive annually declining grants averaging US$45 million (26 percent of GDP as of FY2012) until FY2023.1 A Compact Trust Fund (CTF) is being built up to provide funding from FY2024 onwards.

Recent Developments and Outlook

A. Recent developments

2. The economy grew by 3.2 percent in FY2012, up from a lackluster 0.6 percent in FY2011. The FY2012 growth pick-up was driven by the double-digit expansion in the fishery sector, increased copra and coconut oil production and the expansion of the education sector (Figure 1). Construction activity, however, continued to contract, owing to delays in the implementation of Compact infrastructure projects. In FY2013 growth is estimated at a weaker rate of 0.8 percent, due to further postponement of some construction activities. Employment has remained stagnant in FY2012, with a slight reduction in private sector employment being offset by a small increase in public sector employment. Outmigration slowed in FY2012, after ten years of average annual outflows rates.

Figure 1.
Figure 1.

Marshall Islands: Real Sector and Fiscal Developments

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: RMI authorities; IMF, World Economic Outlook; and IMF staff estimates.

3. Inflation moderated. Year-on-year inflation stood at 4.3 percent in FY2012—1 percentage point lower than in FY2011—and is estimated to have eased even further, to 1.6 percent in FY2013, thanks to subdued world commodity prices.

4. In FY2012 the overall fiscal balance recorded the first deficit (0.8 percent of GDP) since 2005, in spite of favorable growth. The deterioration reflected an increase in transfers to SOEs of 1.1 percent of GDP and a 0.5 percent of GDP rise in the public wage bill, which more than offset an increase in fishing license fees. For FY2013, the fiscal deficit is estimated to have remained at 0.8 percent of GDP, with a further increase in transfers to SOEs broadly offsetting that in fishing license fees. The FY2012 deficit was financed by a drawdown in deposits, while the FY2013 deficit was financed by an Asia Development Bank (AsDB) loan disbursement.

5. The current account deficit including official transfers remained elevated in FY2012 at 8.1 percent of GDP. This was driven by high imports for the airport extension project, financed by capital transfers. Exports continued their expansion, reaching nearly 35 percent of GDP in FY2012. Fishing fees rose to 5.6 percent of GDP in FY2012, from 3.1 percent of GDP in FY2011 (Figure 2). In FY2013 the current account deficit is estimated to have deteriorated to 9.4 percent of GDP, due to the postponement of some donor grants.

Figure 2.
Figure 2.

Marshall Islands: External and Credit Developments

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: Country authorities; IMF, World Economic Outlook; Haver Analytics; CEIC; and IMF staff estimates.

B. Outlook and Exchange Rate Assessment

6. While a growth rebound is expected in FY2014, the medium-term outlook is less promising. Growth is projected at 3.2 percent in FY2014, assuming the resumption of Compact funded infrastructure projects. The pickup in related construction activities is expected to continue through FY2017, and unwind in FY2018, with growth slowing significantly in that year. The fishing sector is expected to expand further, but at a slower pace (Box 1). In the medium-long term, growth potential is projected at about 1½ percent—weighted down by the scheduled reduction in Compact grants and limited private sector expansion. Inflation is expected to remain moderate at 1.7 percent in FY2014, thanks to subdued global commodity prices.

7. A fiscal deficit of 0.2 percent of GDP is projected for FY2014. The temporary improvement compared to FY2013 is driven by one-off revenue factors—a grant from Papua New Guinea and a dividend transfer from the Marshall Islands Marine Resource Authority—more than offsetting increases in education and health spending in response to a US request.

8. The current account deficit is expected to widen in FY2014 to nearly 21 percent of GDP. The deterioration will be driven by the acquisition of two ships provided by a donor to improve domestic transportation, and higher imports for the resumption of infrastructure projects. In the medium term, however, the current account will tighten, as the impact of these temporary factors abates, and thanks to some expansion in fish exports and fishing license fees.

9. The real exchange rate is close to its historical value. The real appreciation in FY2008–09 following the global commodity price shock was largely reversed, and the real exchange rate has remained fairly stable since then. Exports have been expanding and unit labor costs in the fishing sector—the main export—have been declining over the past three years. Current account deficits are financed by a stable source of funding and the use of the U.S. dollar as legal tender and the close ties with the United States provide a shelter against external instability.2

A01ufig01

Real Effective Exchange Rates

(2000=100)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

C. Risks and Spillovers

10. Risks to the outlook are to the downside. In the short-term, further delays in the implementation of infrastructure projects could weigh growth down. The danger of natural disasters is ever-present. Global oil price shocks would have a detrimental impact on growth and other macroeconomic variables. Longer-term risks include inadequate fiscal consolidation ahead of the scheduled decline in Compact grants, climate change, and continued outward migration of the working-age population. On the upside, a decisive push for structural reforms and additional investment in infrastructure and the fishery sector would support growth (Appendix 1). Due to limited international financial linkages, the RMI remains fairly isolated from spillovers from external financial developments. Spillovers from trade linkages are expected to be limited in the near-medium-term given RMI’s low dependence on tourism and relatively stable fish demand.

Marshall Islands: Will the Finishing Sector be the Driver of the Future Growth?

The importance of the fishing sector in the RMI’s economy has grown in recent years. In FY2012 fishing activities contributed 1.2 percentage points to real GDP growth and accounted for about 10 percent of total employment as well as value added. Fish is by far the largest export commodity, constituting nearly 90 percent of total exports (excluding re-exports of fuel). Fishing activities are mostly conducted by private companies, although the RMI government has a 49 percent stake in a joint venture with a local private firm.

Fishing license fees increased considerably in recent years, representing nearly 12 percent of fiscal revenues excluding grants in FY2012. This growth was driven by the implementation of the Vessel Day Scheme (VDS) under the Partners to the Nauru Agreement (PNA). Going forward, although the minimum benchmark price for a fishing day is expected to raise, RMI’s benefits are likely to be subdued due to the lack of demand for fishing vessel-days in its Exclusive Economic Zone.

The fishing sector is projected to continue growing in the medium term, but a number of factors challenge its expansion. Additional expensive investment in fishing equipment is needed for further growth. Low pay, worker absenteeism, and scarcity of fresh water is slowing the expansion of fish processing activities. Furthermore, while fish prices have shown a steady upward trend since 2009, recent data point to a decline. Beyond the near term, climate change poses significant risks by affecting the distribution and abundance of tuna and by causing increasingly frequent and severe storms, which result in high operating costs. Growth in the fisheries sector would also be hampered if additional tuna sustainability restrictions were to be implemented.

bx01ufig01

Employment in Fisheries

(In percent of total employment 1/)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: RMI authorities; and IMF staff calculations.1/ Includes shore based fish processing and vessel support services. Part time workers may be significant.
bx01ufig02

Fisheries Licence Fees Inflows

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: RMI authorities; and IMF staff calculations.
bx01ufig03

Frozen Whole Skipjack Tuna Raw Material Prices

(In USD per metric ton, Bangkok Landings, WPO)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: Thai Union Frozen Products PCL; and IMF staff calculations.

The Authorities’ Views

11. Compared to staff’s projections, the authorities were more optimistic on growth prospects. While they agreed that the resumption of infrastructure projects would be the main driver of growth in FY2014, they saw better growth prospects from copra production in the medium-term. In their view, the new ships from donors will allow higher coconuts collection from producers, and a planned new copra oil refinery will reduce dependence on some imported inputs and raise the value added of exports. The authorities agreed that foreign grants would continue to provide stable funding for current account deficits, and indicated that the use of the U.S. dollar remained appropriate.

12. The authorities considered natural disasters and commodity price shocks to be the main risks to the outlook. Extreme weather episodes due to climate change have adversely affected the country in recent years and are becoming more frequent. Negative shocks to copra prices would affect production and exports, while oil price increases would raise production costs. The authorities also highlighted upside risks from future construction activity and from the fishing sector, as adjustments that are favorable to the RMI are expected for the Vessel Day Scheme (VDS) and the Partners to the Nauru Agreement (PNA) arrangements (Box 1).

Securing Fiscal Sustainability

13. Government accounts are set to remain in deficit in the near term and beyond. After FY2015 annual deficits are expected to widen to around 2 percent of GDP and persist in the medium term, financed by bilateral and multilateral development partners. This projection reflects the expected increase in expenditure for social security contributions for public sector employees from the forthcoming pension reform (paragraph 17). The forecast assumes higher subsidies to SOEs, driven also by some called guarantees (paragraph 15). Due to projected deficits, the central government debt-to-GDP ratio is expected to increase, while public and publicly guaranteed debt is projected to remain on a downward path, as SOEs are assumed to continue servicing their government guaranteed debt.

Policy Issues and Staff’s Views

14. A clear and bold consolidation strategy is urgently needed. Fiscal balances need to turn back into surplus to secure long-term sustainability and build buffers against existing significant fiscal vulnerabilities. These include substantial fiscal risks from SOEs and the social security system (paragraphs 15 and 17), the end of most Compact grants in FY2023, uncertainty about future CTF returns, and prospective costs from climate change.

15. The fiscal adjustment path and composition should strike a right balance between consolidation needs and short-term growth implications. In view of this, staff recommends a permanent cumulative consolidation of no less than 4.5 percent of GDP by FY2018 compared to the baseline. This implies that the government needs to build up a fiscal surplus of 2.6 percent of GDP (about US$4.5 million in FY2012 prices) by FY2018, which will have to be maintained afterwards. This would help the RMI to achieve long-term self sufficiency as well as create some fiscal buffer (Appendix 2). If the government were successful in implementing structural reforms that would boost real growth, the required fiscal surplus from FY2018 would be somewhat lower. The needed adjustment could be achieved through a mix of spending and revenue measures, but that would require strong revenue administration.

Policy Options for Fiscal Adjustment Estimated savings and additional revenues

(Percent of GDP)

article image
Sources: Country authorities; and IMF staff estimates.
  • Fiscal adjustment will necessitate targeted spending cuts. Containing public wages would be essential to produce fiscal savings and reduce the large public-private sector wage gap (Figure 1). A freeze on the nominal wage, taking into account the increase in social security contributions from the forthcoming reform, would save 1.1 percent of GDP by FY2018. The proposals of the Comprehensive Adjustment Program group, tasked by the government to review public expenditure, provide options for additional spending reductions. These include curbing allowances to civil servants—with estimated savings of up to 1 percent of GDP—and reducing public sector civil servant numbers by a targeted reduction in the work force.

  • SOE reforms should be a policy priority. SOE poor performance continues to be a drain on the budget, requiring average annual subsidies of more than 4 percent of GDP since 2010 (Box 2). Moreover, as of FY2012, the government has guaranteed US$34 million (20 percent of GDP) of their debt, including US$28.1 million debt of the National Telecommunication Authority (NTA). This poses a significant risk on public finances, as the company is unable to meet its repayment obligations and has already defaulted on some monthly payments, forcing the government to step in. Some SOEs are also planning to borrow further in FY2014, with a government guarantee. Staff encourages the authorities to assess thoroughly possible risks from these operations. Furthermore, staff urges the authorities to advance expeditiously SOE restructuring, with support from the AsDB and the World Bank, by addressing the key issues of governance, pricing policies, efficiency, enforcement of customers’ payments and cross-subsidization. In view of the needed fiscal adjustment, the aim should be reducing government subsidies to SOEs by at least 1.5 percent of GDP by FY2018. A larger reduction is warranted and may be necessary if revenue gains from the tax reform are on the low end of the forecast range.

  • Approval and swift implementation of the tax reform bill is critical to enhance efficiency and equity as well as tax compliance. The comprehensive tax reform bill, currently before parliament, can rectify several weaknesses of the current system. The reform would make the wage and salary tax more equitable by eliminating unjustifiable exemptions, introducing a uniform deduction, and increasing progressivity. Replacing existing import duties and local government sale taxes with a broad-based and modern consumption tax will enhance efficiency and tax compliance. The replacement of the Gross Revenue Tax with a new net profit tax for large businesses will make corporate taxation more business friendly. The creation of a new client focused and independent Customs and Revenue Authority and a more effective IT support system will improve revenue administration. By broadening the tax base and enhancing tax administration, the tax reform is expected to generate additional revenues of 0.5-1.8 percent of GDP, depending on compliance.

Marshall Islands: State-Owned Enterprises: Recent Developments and Prospects for Reform

SOEs’ size in the RMI economy is significant, but they have failed to contribute to growth. They have total assets of around US$150 million (85 percent of GDP), and account for nearly 8 percent of total employment. However, between FY2004 and FY2012, SOE cumulative value added growth was only 1.7 percent—merely 1 percent of the increase in total GDP. Most SOEs ran operating losses in FY2012, totaling US$15 million (8.5 percent of GDP)—3.1 percentage points higher than the FY2007-11 average.

While operating losses are partly motivated by the need to provide essential services to the outer islands at affordable prices, they are also driven by several deficiencies. Lack of investment and maintenance result in inefficient operation in the public transportation companies, Tobolar, and utility providers. The absence of a comprehensive SOE law and of requirements on directors’ duties and obligations contribute to poor governance and accountability. Tariffs are sometimes unduly kept below operating costs, and one SOE does not pay the public energy company, thus benefitting from cross subsidization.

Some SOEs’ reform initiatives are in train, but the timing of implementation and outcomes remain uncertain. At the authorities’ request, the AsDB undertook a review of SOEs in 2010, and recommended reform actions. With technical support from the AsDB, new SOE legislation was drafted in 2011, and now awaits parliament approval. The Marshalls Energy Company has gone through some restructuring, following the adoption of a comprehensive recovery plan in 2009. The AsDB is also helping to develop and implement strategic plans in other SOEs. The World Bank is working with the authorities on a restructuring plan for the National Telecommunication Authority. Reforms, however, face several challenges, including opposition from SOEs, and may require a long time for approval and implementation.

A01ufig02

SOEs: Current Subsidies and Operating Losses

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: RMI Authorities.

16. Public Financial Management (PFM) reforms are essential to address existing weaknesses in budget reporting and planning. The authorities have worked with the Pacific Financial Technical Assistance Centre (PFTAC) on a comprehensive medium-term PFM Reform Roadmap, including measures to strengthen the budgeting framework, the accounting system, debt management, and revenue administration. The plan still has to be finalized and approved by cabinet. Furthermore, a Fiscal Responsibility and Debt Management Act has been submitted to Parliament, stating that fiscal policy has to achieve and maintain prudent levels of debt, and requiring more stringent and periodic reporting of fiscal developments to parliament. Staff welcomes these initiatives and recommends their rapid approval and implementation. Enhancing the medium-term budgeting framework and integrating it into the annual budget would be particularly important for fiscal policy planning, in view of the scheduled reduction in Compact grants.

17. Social security liabilities constitute a significant contingent fiscal risk and warrant swift reform. From FY2008 through FY2013, total benefits and operating expenses exceeded contributions by more than US$14 million, forcing the social security administration to liquify assets. Under the current system, the fund would be depleted by FY2022. A reform bill is currently before parliament envisaging an increase in both the employer’s and employee’s contribution from 7 to 9 percent, an increase in the retirement age from 60 to 65 and early retirement from 55 to 60, a 22 percent benefit cut, a rise in the taxable ceiling, and measures to reduce misuses of the benefit system. With the reform, the system is projected to record a surplus until FY2022, but further deficits are likely to arise later on. Approving and implementing the reform is an essential first step toward the creation of a more sustainable pension system. Staff encourages the authorities to explore options for even further reforms that would secure full long-term sustainability of the social security system.

A01ufig03

Effects of Social Security Reform

(In Millions USD)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: Marshall Islands Social Security System; and IMF staff calculations.

18. The RMI is assessed to have high risk of external public debt distress, although mitigating factors limit near-term risks. Currently the ratios of present value (PV) of external public and publicly guaranteed (PPG) debt-to-GDP, exports and revenues are all above their respective reference thresholds. RMI’s vulnerability to debt distress is mitigated by the concessionality of most obligations and access to a stable flow of funds from Compacts grants. On the other hand, short-term risks are exacerbated by the uncertainty surrounding SOE reform implementation and their plans to borrow further with government guarantees.

The Authorities’ Views

19. The authorities recognized the need for fiscal adjustment. They intend to achieve a balanced budget in FY2014 through a 25 percent cut in electricity and travel expenses, and build surpluses over the following years. They agreed on the need to contain wage bills, and noted that nominal wages have been unchanged over the past three years and that no increase is planned going forward. The authorities also intend to reduce personnel through a hiring freeze and natural attrition. They also pointed out that the tax and SOE reform bills currently before parliament will help improve the fiscal accounts.

20. The authorities were keen to improve fiscal planning and public financial management. They noted that with the assistance of the AsDB the Ministry of Finance has adopted a fiscal management model that will be used for budgetary planning. They intend to proceed expeditiously with the finalization and implementation of the PFM reform, for which they have requested IMF technical assistance.

21. The authorities acknowledged the need for further pension reforms. They are considering converting the social security system to a defined contribution scheme and are seeking technical assistance in this area.

Boosting Private Sector Development and Financial Stability

A. Private Sector Development

Policy Issues and Staff’s Views

22. Going forward, further private sector development will be essential to support and stabilize growth and, hence, secure fiscal sustainability. In spite of the recent expansion of the fishing sector, the public sector remains the main source of economic activity. Private sector development is limited by remoteness, small size, a poor regulatory framework and weak business climate (Box 3 and Figure 3). In addition, SOEs compete against private enterprises in some sectors, such as telecommunications and hospitality, on an unequal footing, given their access to subsidized credit.

Figure 3.
Figure 3.

Marshall Islands: Factors Impacting Private Sector Development

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: Country Authorities; South Pacific Applied Geoscience Commission; Skype; United Nations Environment Program; World Bank; and IMF staff calculations

23. Policies are needed to enhance private sector growth prospects. The government could work with development partners, the private sector and neighboring countries to upgrade both capital and human resources and to secure cheaper and more reliable air links to and within the country. Structural reforms should address the issues of weak competition due to SOE dominance in some industries and the wide public and private sector wage gap. The authorities could consider the introduction of an insolvency framework and further land registration reforms to facilitate firm access to credit. Furthermore, easing procedures for long-term land leases to nonresidents could help attract foreign direct investment.

The Authorities’ Views

24. There was general agreement about the impediments to private sector development. Structural obstacles on land use were regarded as deeply rooted in tradition, and very difficult to remove. The authorities noted that SOE reforms were underway with the assistance of the AsDB and the World Bank, and indicated that a law to liberalize the telecommunication sector was awaiting parliament approval. They also pointed out that the gap between public and private sector wages was due to the fact that the public sector employs more skilled workers than the private sector.

B. Financial Sector

25. Lending conditions are tight, despite ample availability of deposit funding. The loan-to deposit ratio remained low in FY2012, at around 70 percent, with commercial loans representing only about 20 percent of private sector credit. Spreads between lending and deposit rates stayed elevated at around 7 percent, reflecting the high risk in domestic lending (Figure 2 and 3). Banks operated profitably—with a return on assets of nearly 3 percent in FY2012.

Marshall Islands: Obstacles to Private Sector Development

Private sector growth in the RMI faces considerable obstacles. As in other Pacific Island countries (PICs), small market size, remoteness, dispersion over a wide area, and exposure to natural disasters raise business costs and make it difficult to benefit from economies of scale.

Lack of clarity on land ownership has adverse effects on private sector growth. The complex customary land tenure system implies that at least three parties need to jointly agree on whether a transaction can occur, and written documentation of ownership titles is limited. Hence the RMI is ranked at the bottom of the World Bank’s indicator for “Registering Property”.1 A voluntary registration scheme, initiated in 2009, has been stalled by land ownership disputes. Thus, investors not only have to navigate through a longer process to lease land, but also face risks of legal contest to land usage. Commercial banks have also shied away from accepting land as collateral given potential difficulties in repossessing the asset in the event of default.

bx03ufig01

Doing Business Index, Distance to Frontier, 2013

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: World Bank; and IMF staff calculations.1 The distance to frontier shown is normalized to range between 0 (worst performance) and 100 (the best performance, the frontier).
bx03ufig02

Worldwide Governance Indicators, 2012

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: World Bank; and IMF staff calculations.1 Each governance indicator ranges from -2.5 (weak) to 2.5 (strong) governance performance.

The absence of a legislative framework for bankruptcy and limited investor protection also hampers private sector development. Bankruptcy costs are higher than the regional average, at 38 percent of the estate (compared to an average of 31 percent for PICs) and a recovery rate of just 17 cents on the dollar (compared to an average of 27 cents in the dollar for PICs). Investor protection is also weak, reflecting the lack of disclosure requirements, and a low extent of director liability.

The business climate is not conducive to growth due to weak public governance. The RMI scores poorly in World Bank’s measure of government effectiveness relative to the PICs and other micro states, due to low scores for public administration quality and budgetary and financial management.

1 The World Bank Doing Business indicators should be interpreted with caution due to a limited number of respondents, limited geographical coverage, and standardized assumptions on business constraints and information availability.

26. Household debt remains high. Consumer debt is almost 50 percent of total employees’ compensation, and anecdotal evidence suggests that debt servicing in many cases is as high as 90 percent of borrowers’ income. Recurrent refinancing of existing consumer loans also appears to be quite common. In addition, there are indications that households are increasingly borrowing at higher interest rates from money-lenders which are not regulated by the Banking Commission. The publicly owned Marshall Islands Development Bank (MIDB), which is outside the Banking Commission’s oversight, is engaged in short-term consumer lending as well—an activity regarded as less risky and more profitable.

Policy Issues and Staff’s Views

27. Strengthening the regulatory framework will be critical, especially in view of the high level of household indebtedness. Given the high debt service ratios, small shocks to borrowers’ disposable income (such as higher social security contributions following the implementation of the pension reform) could produce increasing defaults. Hence, the Banking Commission should consider imposing a ceiling on the allowed debt service ratio. The regulatory authority should also introduce homogenous criteria on non-performing loan classification and require regular data reports, since timely and consistent data are not readily available. The Banking Commission should also enforce the legal requirement for deposit insurance—currently being contravened by one bank—, especially given the absence of any insolvency law to protect depositors.

28. The capacity and oversight authority of the Banking Commission should be enhanced. Resource constraints have limited the Commission’s ability to carry out regular on-site bank inspections. Staff also recommends that the Banking Commission be given more authority and autonomy to carry out supervision, as currently, its actions can be reversed by the Cabinet. The MIDB and other nonbank financial institutions that engage in private lending activities should also be brought under the purview of the Banking Commission. The MIDB should refocus on its core mandate of providing commercial lending, rather than consumer loans.

29. The anti-money laundering (AML) framework needs to be stepped up, in particular with regard to the transparency of legal persons. The 2012 OECD Global Forum progress report confirms that measures to ensure availability of information on the beneficial ownership of legal persons still need to be introduced, and effectively implemented. The RMI counts 30,000 active nonresident companies, at risk of misuse in money laundering and tax evasion schemes.

The Authorities’ Views

30. The authorities agreed on the need to enhance the capacity of the Banking Commission to carry out on site inspections. They also considered important to introduce a regulatory framework for non-bank moneylenders and were contemplating establishing licensing requirements and setting up a registry. The Banking Commissioner saw the need to limit recurrent loan refinancing and had made recommendations to the Cabinet in this regard. The authorities also shared staff’s view that the MIDB should be brought under the Banking Commissioner’s oversight. The Commissioner concurred on the importance of establishing a safety net for depositors, but had not formulated a reform proposal yet.

31. The authorities noted that they have made some progress on measures against money laundering. The RMI introduced amendments to existing legislation to cover self-laundering, and addressed some deficiencies on the functionality of the financial intelligence unit. However, budget constraints have resulted in delays in implementing several measures, including on-site reviews of banks and targeted reviews of non-bank institutions.

Staff Appraisal

32. Medium-term growth prospects in the RMI remain weak. In spite of the projected temporary boost from construction projects and some expansion in the fishery sector, beyond the near-term the scheduled decline in Compact grants and sluggish private sector development hinder faster growth.

33. Projected persistent deficits, significant fiscal risks from poorly performing SOEs and the social security system, and the expiration of most Compact grants after FY2023 call for a swift and bold consolidation strategy. This should include urgent and comprehensive SOE restructuring, public wage bill moderation, cuts in civil servants allowances, approval and implementation of the pending tax reform. Approval and implementation of the social security bill currently before parliament, as well as further pension reform, would be essential to secure long-term sustainability. PFM reforms are also needed to improve budget planning, execution and monitoring.

34. The RMI is assessed at high risk of public external debt distress, although the concessionality of most obligations and access to a stable flow of funds from Compact grants mitigate near-term risks. This calls for a very prudent external debt management policy, including seeking concessional loans.

35. The real exchange rate remains close to its historical value. The real appreciation of FY2008–09 has been reversed, and the real exchange rate has remained fairly stable since then. Current account deficits are financed by a stable source of funding and the use of the dollar as legal tender and close ties with the United States provide a shelter against external instability.

36. Private sector development would be critical for both lifting growth and supporting fiscal sustainability. Policies to enhance private sector growth prospects include SOE restructuring and measures to facilitate firms’ access to credit and foreign direct investment.

37. Strengthening the regulatory and supervisory framework would enhance financial stability. Given high household debt and debt service ratios, the Banking Commission should consider imposing a ceiling on the allowed debt service ratio and its supervisory authority should be broadened to include all entities engaging in lending activities. There is also a need to improve monitoring of non-performing loans and to increase the Banking Commission’s resources. Furthermore, the Banking Commission should be given more authority and autonomy to carry out effective supervision. Depositor protection should also be enhanced.

38. The quality of official statistics is broadly adequate for surveillance, but should be improved. Timeliness and coverage of statistics tend to constrain policy planning and assessment. Additional staff training and capacity building would contribute to improving data quality.

39. The authorities have taken a few steps to implement some of past IMF staff recommendations (Appendix III).

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

Figure 4.
Figure 4.

Marshall Islands: Comparison with Other Pacific Island Countries (PICs)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: Country authorities; and IMF staff estimates.
Table 1.

Marshall Islands: Basic Data, FY2009–18 1/

Nominal GDP for FY2012 (in millions of U.S. dollars): 172.5

Population (2011): 53,158

GDP per capita for FY2012 (in U.S. dollars): 3,232

Quota: SDR 3.5 million

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Sources: RMI authorities; and IMF staff estimates and projections.

Fiscal year ending September 30.

Public and publicly-guaranteed external debt.

Table 2.

Marshall Islands: Statement of Government Operations, FY2009–18 1/

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Sources: RMI authorities; and IMF staff estimates and projections.

Fiscal year ending September 30.

Does not include Compact funds earmarked for Kwajalein rental payments and Trust Fund contributions.

Table 3.

Marshall Islands: Balance of Payments, FY2009–18 1/

(In millions of U.S. dollars)

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Sources: RMI authorities; and IMF staff estimates and projections.

Fiscal year ending September 30.

Table 4.

Marshall Islands: External Vulnerability Indicators, FY 2009–18

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Sources: RMI authorities; and IMF staff estimates and projections.

The deposit decline in FY2011-12 is due to expatriation of rent income received by Kwajalein landowners in previous years.

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

Public and publicly-guaranteed external debt.

Table 5.

Marshall Islands: Deposit Money Banks, FY2009–12

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Sources: RMI authorities; and IMF staff estimates.

Fiscal-year basis - 5 quarter average.

Includes deposits of Social Security administration and other trust funds.

Year average.

Average of rates offered by deposit money banks.

Average of minimum rates offered by deposit money banks.

Average of maximum rates charged by deposit money banks.

Table 6.

Marshall Islands: Millennium Development Goals (MDGs) Indicators

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Sources: United Nations Millennium Development Goals Indicators 2013. http://mdgs.un.org/unsd/mdg/Data.aspx

Appendix 1. Marshall Islands: Risk Assessment Matrix 1/

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Appendix 2. Marshall Islands: The Compact Trust Fund-Long-term Outlook and Implications for Fiscal Sustainability

Compact Trust Fund (CTF) returns have been volatile.1 In FY2008, net return on assets was negative (-23 percent), substantially eroding the market value of the CTF. The fund again experienced a negative return in FY2011, after modest gains in FY2009–10. Strong performance in FY2012-13 has brought the value of the CTF to around US$206 million (120 percent of GDP) as of end-FY2013.2

app02ufig01

Compact Trust Fund Oustanding Value

(In millions of US dollars)

Citation: IMF Staff Country Reports 2014, 026; 10.5089/9781616355265.002.A001

Sources: RMI authorities

The CTF is administered by an independent committee. Four voting members on the committee are appointed by the United States, two by the RMI, and one by Taiwan Province of China.3 A custodian and a professional investment advisor help to manage the Fund.

Two scenarios are considered to assess the long-term outlook and the implications for RMI’s fiscal sustainability. Long-term self-sufficiency is assumed to be achieved if after FY2023 the CTF can generate enough investment income to cover the reduction in Compact-sector grants and the Supplemental Education Grant, without eroding the real value of the CTF.4

1. Baseline scenario

Under this scenario of unchanged fiscal policies, persistent fiscal deficits are projected until FY2033, the last year of the analysis, and are assumed to be financed by external borrowing from bilateral and multilateral development partners. This projection reflects also the expected increase in expenditure for social security contributions for public sector employees from the forthcoming pension reform. In view of projected deficits, no additional contributions from the government to the CTF are assumed. The CTF net investment return is assumed at 6 percent, consistent with previous staff analysis and an earlier study by the US Government Accountability Office. This is slightly above the 5.6 percent net average return since the CTF’s inception in 2004, which, however, reflects the impact of unusually dismal earnings in the aftermath of the global financial crisis.

Under the baseline scenario, long-term self sufficiency will not be secured because the real value of the CTF will decline over time, even though income flows in the years immediately after FY2023 are expected to be sufficient to cover the anticipated reduction in grants. Compact-related grants are expected to be reduced by US$32.0 million in FY2024, while the CTF’s investment earnings are projected at US$37.6 million. The gap between the investment return and reduction in grants will be too small to compensate for the increase in inflation,5 so the real value of the fund will start declining in FY2024.

2. Policy action scenarios

In the first scenario, the government is assumed to undertake a fiscal adjustment of 0.9 percent of GDP each year starting in FY2015—building a surplus of 1.7 percent of GDP in FY2018—and maintain the same surplus after FY2018, and transfer surpluses to the CTF or invest them in another trust fund with the same return. Under this course of actions the real value of the total asset would be preserved at least until FY2033, the last projection year. The surplus required to achieve self sufficiency is lower than past staff’s estimates due to the improved performance of the CTF. However, this outcome is sensitive to the assumption on investment returns.6 For example, a 1 percentage point decline in investment return would increase the needed adjustment to more than 6 percent of GDP over a 4-year period. Hence, to cushion against CTF return volatility, and taking account the growth implications of fiscal adjustments, staff recommends a permanent cumulative consolidation of no less than 4.5 percent of GDP by FY2018.

Required Minimum Fiscal Adjustments under Different Scenarios

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Source: IMF staff estimates.

Appendix 3. Marshall Islands: Main Recommendations of the 2011 Article IV Consultation

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1

The fiscal year runs from October to September.

2

A formal CGER-type analysis was conducted. However, that assessment framework is not fully suitable for the RMI due to data limitations and the special characteristics of its economy, most notably the heavy dependence on aid. The analysis points to a real undervaluation in the range of 9–38 percent, as estimated current account deficit norms are very large—due to a significant economic development gap relative to trading partners and negative oil balances—whereas underlying current account deficits are much smaller, reflecting the impact of stable foreign government grants.

1/

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability of 30 percent or more). The RAM reflects staff’s views on the source of risks and overall level of concern as of the time of discussion with the authorities.

1

The Compact Trust Fund for the RMI was created in 2004 to contribute to the long-term budgetary self-reliance by providing the RMI Government with an ongoing source of revenue after FY2023. The amended Compacts and their subsidiary agreements contain no commitments, either express or implied, regarding the level of the revenue that will be generated by the Trust Fund, nor is there any commitment regarding the degree to which the revenue will contribute to the long-term budgetary self-reliance of the RMI.

2

In addition to this, the D account of the CTF, which received contributions from the RMI’s government and Taiwan Province of China, held US$11.4 million as of end-FY2013.

3

The CTF committee has no oversight or fiduciary responsibility of the D account.

4

The analysis is thus based on a broader perspective than what the CTF was designed to specifically support.

5

Inflation is measured by the GDP deflator.

6

On the other hand, if the government were successful in implementing structural reforms that would boost real growth to 2 percent by FY2018, the required fiscal surplus from FY2018 onwards would fall to 1.5 percent.

Republic of the Marshall Islands: Staff Report for the 2013 Article IV Consultation
Author: International Monetary Fund. Asia and Pacific Dept