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.
The Republic of the Marshall Islands (RMI)’ authorities wish to express their appreciation to the mission team for their constructive policy consultation and the well-structured report. Due to the unique challenges of micro states such as extreme remoteness, small population, dispersion and narrow production base, the RMI has undergone difficulties in achieving self-sustaining economy, and has relied on external supports. The authorities appreciate the continued support from the international community, particularly from the United States, in providing financial support through the Compact of Free Association.
The RMI authorities are broadly in line with the staff report, which properly identifies the country’s economic status and highlights the need for securing fiscal sustainability and boosting private sector development. They will continue their efforts to address the challenges and rebuild policy buffers for enhancing economic resilience and promoting potential growth.
Recent Economic Development
Economic growth of the RMI has fluctuated over the past few years, showing its vulnerability to external shocks. Real GDP growth, which picked up by 3.2 percent in FY2012 from 0.6 percent in FY2011, is projected to slow down to below one percent in FY2013 due to delays in project implementation of Compact infrastructure projects. As those projects start to resume, growth is expected to reach above three percent in FY2014.
Risks to growth are tilted to the downside. As staff noted, main sources of domestic risks include further delays in project implementation, insufficient fiscal consolidation and contingent liabilities in the public sector. The danger from natural disasters and commodity price shocks also pose considerable risks to the outlook, reinforcing the importance of maintaining large policy buffers to absorb shocks. There are also upside risks, such as bold implementation of structural reforms and better prospects of copra production from new ships and a new copra oil refinery.
The authorities are committed to their continued efforts for a gradual transition toward self sustainability as the Compact comes to an end in FY2023. Last December, they reviewed the progress of the RMI’s National Strategic Plan, which sets goals for sustainable development of the country. No transfers from the authorities were made to the Compact Trust Fund (CTF) in FY2013 due to fiscal deficits. Nevertheless, the authorities acknowledged the importance of securing long-term self sufficiency of the CTF, which will be a source of revenue after FY2023.
Fiscal Sustainability
The authorities agree with staff that considerable fiscal adjustment is crucial while taking into account the right balance between consolidation needs and growth implications. A fiscal adjustment of 4.5 percent of GDP by FY2018 is not an easy task, but the authorities fully recognize the need for fiscal consolidation, noting that further delay would make it difficult to achieve sustainable growth. They aim to reach a balanced budget in FY2014 from the consecutive deficits of 0.8 percent in the previous two years. Fiscal position would be further improved once the pending tax and SOE reform bills are passed in the Parliament this year. The authorities will continue to freeze the nominal wages so as to reduce the public-private sector wage gaps over time, which are partly due to the differences in skills between workers.
Tax reform will contribute to enhancing efficiency and compliance in the tax system. The purpose of this comprehensive tax reform bill, which is under discussion in the Parliament, is to modernize the tax system by broadening the tax base and strengthening tax administration through measures such as introducing a consumption tax and establishing an independent Customs and Revenue Authority. The authorities will continue their efforts for approval and implementation of this significant bill.
The authorities are actively working to implement SOE reforms. Liberalizing the telecommunication sector is under discussion in the Parliament and an initial study has been completed on the feasibility of privatizing the airline sector. The authorities note that SOEs have become a substantial burden on the government, and reassure that they would push forward the SOE bill to be passed in the Parliament, which contains international best practices of good governance, commercial test and less government involvement. In restructuring SOEs, the authorities will give proper consideration to the impact on the most vulnerable people, who depend on the services of SOEs.
The authorities are exploring ways to reform the social security system to secure its sustainability. It is estimated that the social security fund will be depleted by 2022 under the current system and this may result in a considerable contingent fiscal risk. In this sense, the authorities have drafted a reform bill, which is pending the Parliament approval. The bill aims to cut current benefits by 22 percent and to increase contribution and retirement age, thereby producing $3 million/year surplus. The authorities are also considering converting to a defined benefit scheme and, in this regard, the Fund’s technical assistance would be appreciated in this area.
Strengthening public financial management is another important policy priority for the government. The authorities have worked with the Asian Development Bank (ADB) and the Pacific Financial Technical Assistance Centre (PFTAC) in preparing a roadmap for fiscal prudence and public debt management. This would improve allocation of resources and enhance the medium-term budgeting framework.
Financial Sector Development
The authorities agree to the need for strengthening regulatory framework. The financial sector remains focused on consumer lending and the authorities are aware of the need for vigilance in monitoring high levels of household debt. They are also considering bringing in medium and small moneylenders under the formal regulatory framework.
Enhancing the capacity of the Banking Commission is also important for financial stability. The role of the Banking Commission has been expanded for on/off-site examinations of banks and the authorities welcome staff’s recommendation to increase the Commission’s resources and to put the Marshall Islands Development Bank under the supervision.
Boosting Private Sector Development
Private sector could play a more dynamic role as the engine of economic growth. The contribution of private sector on economic growth has increased to 29.5 percent (FY2010–FY2012) from 26.7 percent (FY1997–FY1999), reflecting the rise of the fisheries sector. The authorities will continue to take further steps to improve business environment and to encourage entrepreneurship in achieving a self-sustaining business sector. The fisheries sector would continue to be a source of growth and business development in niche/eco-tourism could also be a profitable one.
The authorities will continue their efforts for easing the obstacles to private sector development. They emphasize that there were some progress in registering land and that they will tackle further the land ownership issue, while noting that this will take considerable time and effort due to the complex nature of the Marshallese land tenure system. Ensuring proper infrastructure and legislative framework will help reduce costs in running businesses and providing a level playing field to investors will attract foreign direct investment.