Statement by Hazem Beblawi, Executive Director for Maldives and Wafa F. Abdelati, Senior Advisor, February 11, 2015

This 2014 Article IV Consultation highlights that Maldives’ real economy has picked up. Growth is estimated to have reached 5 percent in 2014 with stronger tourism activity driven by a rapid expansion from Asian markets and a tepid recovery from Europe. The IMF staff expects growth to be about 5 percent in 2015. Weaker import prices have pushed down inflation to low levels. Growth is expected to remain relatively strong in the near term, though the fiscal adjustment envisaged in the 2015 Budget will have a mildly negative effect on growth.

Abstract

This 2014 Article IV Consultation highlights that Maldives’ real economy has picked up. Growth is estimated to have reached 5 percent in 2014 with stronger tourism activity driven by a rapid expansion from Asian markets and a tepid recovery from Europe. The IMF staff expects growth to be about 5 percent in 2015. Weaker import prices have pushed down inflation to low levels. Growth is expected to remain relatively strong in the near term, though the fiscal adjustment envisaged in the 2015 Budget will have a mildly negative effect on growth.

At the outset, we would like to thank staff for their insightful analysis, constructive discussions, and well-written reports. The Maldives’ authorities highly value the expert advice of the Fund, much of which they agree with, and the effective technical assistance, which they have consistently implemented. They consider the report to reflect positively on developments in the Maldives and particularly appreciate staff’s recognition of the specific structural challenges that Maldives faces due to its small population disbursed among so many different islands. This Article IV discussion comes at a time of large data revisions, which places the country in a much better position compared with the alarming assessment in the last report. The authorities fully appreciate staff’s difficult position of working with substantial data revisions. However, it is important to underscore that these data revisions are due only to improvements in compilation and coverage, which are based on the recommendations of technical assistance provided by the Fund. The authorities are grateful for the Fund’s continued support in improving macroeconomic statistics as well as other areas of technical assistance.

Background. The Maldivian economy is heavily dependent on fisheries and tourism, which have been the major sources of growth, foreign exchange earnings and government revenues. Maldives’ economy grew rapidly in the two decades prior to the December 2004 Tsunami, powered by successful development of its tourism sector. Per capita incomes rose to upper middle income levels and social conditions improved commensurately. However, the country was severely hit by a series of natural disasters and external shocks — the tsunami, the 2007-2008 food and fuel crisis, and the subsequent global financial crisis. As a result, the pace of economic activity has been uneven in the past decade and macroeconomic management has been somewhat complicated by the process of political transition to democracy. A sharp slump in tourist activity in 2009 and then again in 2012 reflected the slowdown in Europe, whose share fell from two thirds to one third of tourist arrivals to the Maldives. The picture is more positive now. The real economy is picking up driven by a recovery in tourism activity1 due to the expansion of new Asian markets, the fiscal position has improved, inflation is very low, and banking soundness has improved.

Fiscal revenue, which is highly dependent on tourism, declined by about 10 percentage points of GDP between 2007 and 2009, and the public sector wage bill surged following the 2008 elections, which prompted the authorities to seek a Stand-By Arrangement in December 2009. At that time, the central government fiscal deficit was estimated at around 30 percent of GDP and a drastic fiscal consolidation was targeted under the program. In the event, the program was interrupted after the first review, mainly because staff was uncertain that the authorities’ policies could deliver the envisaged reduction in the fiscal deficit. Nevertheless, the objectives of the 2009 program were largely achieved, particularly with respect to raising sustainable budget revenues, reducing the overall and primary fiscal deficit, and significantly raising international reserves. This experience underscores the authorities’ commitment to implement significant reforms, even without a program and while going through political transitions. Moreover—as aptly highlighted in the staff report—the recent balance of payments revisions point to a considerably lower current account deficit than previously believed.

Fiscal Policy. The authorities intend to build on the recent fiscal consolidation. The primary fiscal deficit was reduced from 17 percent of GDP in 2009 to 5½ percent of GDP in 2013 according to staff’s estimates (or 2½ percent according to preliminary estimates of the Ministry of Finance), which is a remarkable achievement by any measure. It also far surpasses the episodes of large fiscal consolidation presented by staff in Box 4. This was achieved by introducing a General Sales Tax in 2011 and later broadening its base and raising the rate, a new Business Profits Tax in July 2011, as well as raising duties and some charges. However, the introduction of the universal health program and other social welfare contributions, which were considered a social priority, have since then contributed to rising current spending and crowding out capital expenditures.

The 2015 Budget targets an ambitious further consolidation. Revenue measures include a “green tax” to be levied tourists instead of the bednights tax, raising import duties on some zero rated items, new resorts licenses and land acquisition fees from the Special Economic Zones. Meanwhile, a public employment freeze will be implemented and electricity and food subsidies will be cut, seizing the opportunity of low global oil and food prices and identifying steps to improve targeting. The authorities expect this package to eliminate the primary deficit and set debt on a downward and sustainable path as stipulated in the Fiscal Responsibility Act, introduced in 2013, which aims to limit public debt to 60 percent of GDP, down from the current level of 75 percent of GDP.

In any case, the authorities are keen to review local government pay structures, and they view a public pay body as potentially helpful to ensure consistency of wages and salaries across public service and to move in the direction of public service reform. The authorities consider strengthening public financial management a key priority that will contribute to achieving fiscal sustainability. They attach high importance to reducing the long-standing stock of government arrears and preventing further accumulation. They are accordingly requesting additional technical assistance from the Fund, particularly in the area of the fiscal chart of accounts and budget execution. Additional revenue measures could be considered, if needed. The staff suggests that the authorities undertake additional fiscal measures equivalent to 3 percent of GDP, which would be manageable. The authorities may out-perform staff’s fiscal projections as has been the case in the past2.

External Sector Assessment. The authorities welcome staff’s revised external sector assessment. They view the current exchange rate regime to be suitable for Maldives given the high degree of openness and seasonality of tourism revenues. Past exchange rate devaluations have been unsuccessful (of which the latest is the 2011 experience) as the rapid inflation pass-through offset the impact of the nominal exchange rate devaluation. Continuing to improve the fiscal position is seen as the best way to sustain the exchange rate within its current band. The authorities particularly appreciate the additional background work prepared by staff to better understand the functioning of the foreign exchange market and revise balance of payments estimates, consistent with the authorities’ previous requests. For their part, the authorities have begun to collect more regular information on the operations of exchange bureaus.

Monetary and Financial Policies. The Maldives Monetary Authority (MMA) remains committed to its objectives of maintaining price stability and an adequate level of international reserves, while promoting non-inflationary economic growth. Although monetary aggregates have been growing rapidly as the MMA accumulates reserves, private sector credit growth has remained subdued as banks are cautious in extending new credit. The authorities consider the reduction of the minimum reserve requirement necessary given its unusually high level3 and the handling of the government’s overdraft the best way to facilitate achievement of the targets under the Fiscal Sustainability Law. The policy stance was eased in 2014 in response to macroeconomic conditions, including very low inflation. The MMA stopped monetizing the deficit since April 2014, and monetary policy decisions have not been influenced by government finance considerations. The MMA continues to absorb liquidity through its overdraft facility while it has only temporarily stopped conducting Open Market Operations. Steps are being considered to deepen and develop the Treasury bill market and to introduce longer term instruments. Financial soundness indicators continue to improve as the strengthening of loan portfolios reflects a revival in the tourism and construction sectors.

Medium term prospects. The authorities are optimistic that medium-term growth will pick up following the development of the new airport, implementation of current plans to improve infrastructure, and investments in the Special Economic Zones. Diversifying the economy beyond tourism and creating employment opportunities is a high priority. These plans are intended to boost growth potential and will help build buffers against external shocks. The authorities are well aware of the external vulnerabilities faced by all small open tourist-dependent states. The risks outlined in the Matrix are plausible but appear to be over-stated. The tourism sector has out-performed other peers and Maldives has a broad spectrum of source countries and still substantial unmet demand by international visitors.

In closing, we welcome the shift to a more positive staff assessment, which reflects important policy achievements, favorable economic developments, and data revisions as recommended by the Fund. We look forward to continued close engagement with the Fund as the authorities tackle remaining challenges.

Table 1.

Maldives—Staff’s Data Revisions Since the Last Article IV Report

(in Percent, Million Rufiya, Million $, or Percent of GDP as indicated)

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1

More recently, Chinese tourists have continued to grow and now constitute the largest single source country for the Maldives. See “Changing Dynamics in the Maldivian Tourism Industry: Chinese Tourists and Average Length of Stay” by: Azeema Adam and Aishath Zara Nizar, MMA Research Papers, Volume 1 Number I, June 2014.

2

The authorities targeted an overall fiscal deficit of 4 percent in 2013, and the last staff report had projected a deficit exceeding 16 percent of GDP, but staff’s latest estimate places it at under 8 percent.

3

Effective from 20th February 2014, the Minimum Reserve Requirement was reduced from 25 percent to 20 percent of the average local and foreign currency deposits, excluding interbank liabilities and L/C margin deposits.