KEY ISSUES Context. Raising growth and ensuring long-term fiscal sustainability remain the two critical issues of the FSM. The reform agenda, in particular, the tax reform package and growth-enhancing reforms, hinges on achieving a national consensus in a loosely federated nation. Outlook. The economy stagnated in FY2014 (ending September) with real growth estimated at 0.1 percent, reflecting a slowdown in the implementation of infrastructure projects. Inflation dropped to 0.7 percent in FY2014 on account of falling oil prices. The current account strengthened due to a tax windfall from a company’s sale of shares launched on a foreign stock exchange and an increase in fishing license fees. Growth in FY2015 is expected to remain almost flat at 0.3 percent, while damages caused by the recent typhoon Maysak could dampen the economy. Fiscal sector. The authorities have started some reforms in view of the expiration in 2023 of grants provided under the Compact of Free Association with the U.S. State governments have started fiscal consolidation while the Unified Revenue Authority (URA) has been established. The authorities agreed that more needs to be done to achieve fiscal sustainability, in particular, by implementing the tax reform package that includes replacing the state sales taxes with a VAT. They noted that further reforms hinge on achieving a national consensus. Investment climate. Land tenure issues continue to constrain private sector development and the authorities should redouble efforts in expediting the land survey and registration process. On tourism, the authorities expressed optimism that the recent extension of the runway at the main island airport in Pohnpei could lead to more eco- tourism that preserves the cultural heritage and pristine nature of the country. Financial sector. Credit unions are currently not being supervised and a new legislation is underway to put them under the supervision of the Banking Board. The authorities have requested further TA from PFTAC and the Legal Department of the Fund.

Abstract

KEY ISSUES Context. Raising growth and ensuring long-term fiscal sustainability remain the two critical issues of the FSM. The reform agenda, in particular, the tax reform package and growth-enhancing reforms, hinges on achieving a national consensus in a loosely federated nation. Outlook. The economy stagnated in FY2014 (ending September) with real growth estimated at 0.1 percent, reflecting a slowdown in the implementation of infrastructure projects. Inflation dropped to 0.7 percent in FY2014 on account of falling oil prices. The current account strengthened due to a tax windfall from a company’s sale of shares launched on a foreign stock exchange and an increase in fishing license fees. Growth in FY2015 is expected to remain almost flat at 0.3 percent, while damages caused by the recent typhoon Maysak could dampen the economy. Fiscal sector. The authorities have started some reforms in view of the expiration in 2023 of grants provided under the Compact of Free Association with the U.S. State governments have started fiscal consolidation while the Unified Revenue Authority (URA) has been established. The authorities agreed that more needs to be done to achieve fiscal sustainability, in particular, by implementing the tax reform package that includes replacing the state sales taxes with a VAT. They noted that further reforms hinge on achieving a national consensus. Investment climate. Land tenure issues continue to constrain private sector development and the authorities should redouble efforts in expediting the land survey and registration process. On tourism, the authorities expressed optimism that the recent extension of the runway at the main island airport in Pohnpei could lead to more eco- tourism that preserves the cultural heritage and pristine nature of the country. Financial sector. Credit unions are currently not being supervised and a new legislation is underway to put them under the supervision of the Banking Board. The authorities have requested further TA from PFTAC and the Legal Department of the Fund.

Overview

1. Context. The Federated States of Micronesia (FSM) is a microstate in the Pacific with one of the most dispersed population in the world. It is highly dependent on external aid, mainly from the United States. The FSM has a loosely federated structure, with four states each having its own executive and legislative bodies. This makes decision making at the national level difficult – a number of reform agendas are experiencing protracted delays.

2. Growth and social indicators. The private sector has yet to become the engine of growth for the economy, and caters largely to the needs of the public sector. FSM’s average annual growth rate between FY20051 and 2013 was close to zero and is worse than other countries in the Pacific2 (Figures 1 and 2). The FSM is endowed with bountiful natural resources and has a strong tradition of caring and sharing through the extended family. While there are no data to track hunger in the FSM, the fact that a relatively small proportion of the population (11 percent) live below the national food poverty line suggests that extreme poverty and poverty-caused hunger are not widespread3, while the disappointing growth has had some negative impact on the progress of Millennium Development Goals.

Figure 1.
Figure 1.

Micronesia: Economic Developments

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Figure 2.
Figure 2.

Micronesia: Regional Comparison of Recent Developments

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: FSM authorities and Fund staff calculations.
A01ufig1

Geographical Dispersion: Average Sea Distance Between Two Inhabitants of the Same Country

(In kilometers)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Micronesia: Millenium Development Goals (MDGs) Progress

article image
Source: 2013 Pacific Regional MDG Tracking Report, Pacific Islands Forum Secretariat.

3. Long-term fiscal challenge. The FSM faces a long-term fiscal challenge as US grants provided under the Compact of Free Association (Compact grants) will expire in FY2023. Compact grants disbursed in FY2013 for current and capital spending amounted to about 25 percent of GDP4, accounting for more than 40 percent of the general government revenue. The authorities have recently produced the “2023 Action Plan” with the view to addressing the long-term fiscal challenge while accelerating the economic growth (Box 1). At this juncture, most of the policy actions included in the Action Plan, including the tax reform package that will play a critical role in enhancing the fiscal revenue, remain to be endorsed by the legislatures.

4. Trust funds. A portion of the Compact grants have been disbursed into the Compact Trust Fund (CTF), jointly managed by the US and the FSM, with the view that returns from the trust fund would be sufficient to enable Micronesia to become fiscally sustainable after FY2023. The FSM has also established its own trust fund (FSM Trust Fund). However, at current pace of accumulation, returns from these funds are expected to fall short of the expired Compact grants in FY2023 – hence the need to step up fiscal consolidation and growth-enhancing structural reforms.

Economic Context

5. Growth. The economy is stagnating. While delays in the compilation of economic data have hampered the assessment of the economy, staff estimates real GDP growth to be around 0.1 percent for FY2014. Externally-funded infrastructure projects are moving slowly: land tenure issues continue to hold back the implementation of some projects while delays in updating the infrastructure development plan of 2004 have resulted in the temporary suspension of Compact infrastructure grants for new projects. Falling oil prices resulted in the decline of CPI from 2.1 percent in FY2013 to 0.7 percent in FY2014.

Micronesia: Selected Economic Indicators, FY2011-15

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Sources: FSM authorities and Fund staff estimates.

Does not include contributions to the Compact Trust Fund.

6. External balance. The current account improved from a deficit of -10 percent of GDP in FY2013 to 2½ percent of GDP in FY2014. The main driving force behind this was a tax windfall from a company’s sale of shares launched on a foreign stock exchange and an increase in fishing license fees. Staff projects that the fishing license fee will stay at the same level in the medium term. Export of goods, at around 15–16 percent of GDP, continues to be concentrated in exports of tuna to Thailand and other East Asian countries.

7. Outlook. The economy is expected to be sluggish in FY2015, as the difficult business climate will continue to hamper private sector growth while the implementation of externally-financed infrastructure projects is likely to experience further delays. Damages caused by the recent Typhoon Maysak5 could further dampen the economy. The continued pass through of low oil prices will result in further decline in consumer prices. In this context, staff projects growth at 0.3 percent for FY2015.

8. Risks to the outlook. Overall, risks are tilted to the downside (Appendix 2). The loosely federated structure of the country could result in further delays of the much-awaited reform agenda. While the “2023 Action Plan” shows a number of essential reforms for the future of the FSM, it remains a plan that needs to be underpinned by a multitude of legislative measures. Natural disasters such as tropical cyclones could cause damages that are significant compared to the small size of the economy. On the upside, further decline in oil prices and faster-than-expected implementation of structural reforms could boost the economy. As the Micronesian economy is heavily dependent on the public sector and foreign grant assistance, changes in the global economy would not have much impact. However, it may affect the tourism industry that the authorities are promoting.

9. Authorities’ view. The authorities broadly agreed with staff on the outlook. They shared the view that achieving national consensus to implement the policy actions included in the “2023 Action Plan” will be the key to boost the economy and ensure long-term fiscal sustainability beyond the expiration of Compact grants in 2023. In this regard, the authorities noted that an extensive public awareness campaign has been put in place to gain a nationwide support, including in places outside of the country (e.g., Guam and Hawaii) where there is a large Micronesian community.

Policies to Achieve Sustainable Growth

A. Fiscal Policy

10. Recent developments. Fiscal revenue excluding foreign grants increased in FY2014 by 10 percent of GDP, on account mostly of higher fishing license fees (4 percent of GDP) and a tax windfall from a company’s sale of shares launched on a foreign stock exchange (7 percent of GDP). Against this backdrop, the national government transferred $30 million (10 percent of GDP) to the trust funds out of the surplus realized in FY2014 and plans to allocate more funds for infrastructure in FY2015. State governments have started fiscal consolidation efforts under their respective Long-Term Fiscal Frameworks (LTFF), which envisages a contraction of current expenditures by 2 percent per year on average in real terms. Taking all these into account, staff estimates that the overall fiscal surplus will decline to 3 percent of GDP in FY2015 from 10 percent in FY2014.

11. Medium-term fiscal framework. The authorities should formulate a medium- to long-term fiscal framework that covers both the national and state governments, with a view to achieving budgetary self-reliance in the post-2023 period. To this end, an inclusive process underpinned by extensive consultations with stakeholders across the country will be critically important – this will help ensure that the fiscal strategy can be implemented with the required legislative measures over a medium term. The framework should adopt the outstanding value of the trust funds (Compact Trust Fund and FSM Trust Fund) in percent of GDP as the fiscal anchor.

  • Target value of the trust funds asset (see Box 2). The trust funds value should reach 340 percent of GDP in FY2023 through a combination of increased revenue efforts and expenditure reforms. At this level, the trust funds will be able to generate sufficient returns to make up for the expiration of the Compact grants in FY2024. Even after adjusting the annual draw downs with the inflation rate, trust funds value will remain around 300 percent of GDP in FY2034.

12. Tax reform and tax administration. The long-debated tax reform package should be implemented over a period of 4 years starting from FY2016, generating additional tax revenue of 4 percent of GDP when fully implemented (1 percent of GDP per year). Micronesia’s tax revenue is low (12–13 percent of GDP), while the average in the Pacific is close to 20 percent of GDP. The mission welcomes the recent establishment of the Unified Revenue Authority (URA) by the national and 2 state governments (Chuuk and Kosrae). The URA should be extended to cover the remaining two states (Pohnpei and Yap) while further enhancing tax compliance, in particular of large tax payers. At the request of the authorities, PFTAC has recently started to provide TA in this area.

A01ufig2

Tax Revenue, 2013

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: Fund staff estimates.

Main elements of the tax reform package

article image
Source: FSM authorities

Major corporations are already subject to a corporate income tax.

13. Expenditure reform. Staff welcomes the recent start of fiscal consolidation efforts at the state level under the LTFF. However, more needs to be done to achieve the targeted value of the trust funds (340 percent of GDP) in FY2023. This will require additional fiscal consolidation of 1 percent of GDP and the LTFF should be extended to the national government as well. Fiscal consolidation should be accompanied by improvement in the quality of public spending, so as to safeguard priority spending in the social sector and infrastructure investment with high development impact. Micronesia’s overall wage expenditure, at 22 percent of GDP, is among the highest in the Pacific. Better coordination between the national and state governments could result in savings by minimizing redundancies of functions between the two levels of governments. While qualifications required for private and public sector may not be fully comparable, public sector wage should continuously be reviewed6. The national government is undertaking a public administration reform project, which includes the review of staff number, pay structure and staff grading. The state governments are reviewing their expenditure including the wage bill under the LTFFs. PFTAC is providing TA to strengthen Public Financial Management and improve the quality of spending with limited resources.

A01ufig3

Government Current Expenditures, 2014

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: Country authorities; and Fund staff estimates.

14. Transfer of fiscal surplus to the trust funds. Staff welcomes the recent transfer of $30 million to the FSM Trust Fund, thus saving the fiscal surplus resulting from the tax windfall from a company’s sale of shares launched on a foreign stock exchange and the increase in the fishing license fee revenue in FY2014. Going forward, fiscal surpluses should continue to be transferred in full to the trust funds. The trust funds should continue to be managed prudently to ensure that funds are appropriately managed for the post-2023 period.

15. Externally-funded infrastructure projects. The unused balance of already allocated Compact grants for infrastructure projects reached almost US$ 140 million (about 40 percent of GDP) at the end of FY2014. Authorities should work closely with all the stakeholders to address the issue, including by updating the infrastructure development plan of 2004 with TA from the ADB in order to prioritize projects in light of their development effectiveness and implementation capacity of each state7. Improving the planning and management of the projects, in particular through better coordination between the national government and state governments, would also be important.

16. Authorities’ Views. The authorities broadly agreed with the staff view of the overall strategy.

  • The authorities emphasized that achieving national consensus across the four states and the national government for both the expenditure and revenue reforms will be critically important. They noted that the “2023 Action Plan” calls for the implementation of a number of policy actions, including the tax reform package which should be implemented by FY2018 by both the national and state governments.

  • The authorities noted that the national government has recently developed a Public Financial Management Roadmap to achieve improved transparency in accounting for public funds and increased availability of information on annual budgets and financial statements.

B. Enhancing Private Sector Growth

17. Background. Improving the investment climate is key in achieving private sector-led growth in the FSM. Currently, FSM’s overall investment climate is ranked among the worst in the Pacific (145th among 189 economies in the world). Structural issues, including in the area of land ownership, combined with the remoteness of the country, are key bottlenecks for private sector development. Private sector is largely dependent on the public sector, and is not an engine of growth as of now.

  • Land tenure issue. In the FSM, most properties are held as family trusts and land use rights are passed down from generation to generation within the extended family. This makes it difficult for potential investors to secure a long-term land lease. Use of land as collateral is also difficult due to family ownership of the land, which is compounded by uncertain boundaries and titles. While complex in nature and closely related to the local traditions, the authorities should redouble efforts at land reform, including by expediting the land survey and registration.

  • Tourism. FSM’s tourism income (7 percent of GDP in 2013) lags behind several of its peers in the Pacific. The recent grant-financed extension of the runway at Pohnpei Airport could open the way for expanding tourism. The authorities are making efforts to establish direct air connections to destinations in Asia, including by signing open sky agreements and arranging chartered flights. Nonetheless, the issue of land ownership will be a crucial factor in developing tourism, including the availability of land for new hotel investment. Also, attention needs to be paid to safeguard the cultural heritage and pristine nature of the country, key to achieving national consensus for the promotion of tourism.

  • Others. The “2023 Action Plan” reconfirms the challenges pointed out by the World Bank Group’s Doing Business Report persist, including the time required in resolving a commercial dispute before local courts (5.3 years on average) and the elevated cost for creditors in recovering debt from insolvent debtors (average recovery rate is 3.3 cents on the dollar). Review of applications for inward foreign direct investment should be expedited.

A01ufig4

Tourism Income, 2013

(In percent of GDP)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: Fund staff estimates.
A01ufig5

Micronesia: Ease of Doing Business, 2015

(Rank out of 189 countries) 1/

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: World Bank, Doing Business 2015.1/ Highest rank = 1; lowest rank = 189.
A01ufig6

Ease of Doing Business, 2015

(Rank out of 189 countries) 1/

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: World Bank, Doing Business Report 2015.1/ Highest rank = 1; lowest rank = 189.

18. Authorities’ Views. The authorities broadly agreed with the assessment by staff that a more robust private sector is indispensable for the future of the FSM, and emphasized that a number of policy actions are included in the “2023 Action Plan”. They also explained that they plan to receive TA from the World Bank Group to review all investment and other relevant laws in the FSM to identify areas of discrepancies. To facilitate foreign direct investment, the authorities are considering establishing an Investment Promotion Agency at the national level to act as a one-stop-shop.

C. Preserving Financial Stability to Support Growth

19. Background. The difficult business environment, in particular, complexities in securing a land lease and using land as collateral, has resulted in the scarcity of bankable projects. At the same time, the number of deposit accounts with commercial banks8 per 1,000 adults reached 565 in 20139, increasing by more than 30 percent since 2004. Reflecting the lack of bankable projects, the loan-to-deposit ratio of commercial banks is very low at 24 percent in FY2014 and the majority of deposits are invested overseas in safe financial assets10 (Table 4).

A01ufig7

Deposit accounts with commercial banks, 2013

(Per 1,000 adults)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: IMF, Financial Access Survey.

20. Credit unions. While commercial banks are well-capitalized and have sufficient liquidity and subject to the supervision of the Banking Board, credit unions, while small in their size, are not subject to any prudential oversight. Staff welcomes on-going initiative by the authorities to enact a new Credit Union Act that will place credit unions under the supervision of the Banking Board, with TA provided by PFTAC and the Legal Department of the Fund.

21. Authorities’ views: The authorities emphasized that they have been working closely with PFTAC and the Legal Department of the Fund to prepare a Credit Union Act that will expand the supervisory mandate of the Banking Board over credit unions. They also noted the need to achieve a national consensus in order to have the new law approved by the legislature. On the business environment, the authorities reiterated the importance of implementing the policy actions included in the “2023 Action Plan”, in particular, those related to regulatory and land reforms.

D. External Stability

22. Background. Risks to external stability are limited, as current account deficits have mostly been financed by non-debt creating foreign capital grants for infrastructure projects. While the trade and service balance had a large deficit, it was partially offset by official transfers and fishing license fees. Compact-related grants will continue to provide a stable source of funding until FY2023. However, under the baseline scenario that does not envisage major policy actions, the authorities will have to take on concessional external loans from FY2024 onwards in order to safeguard priority developent spending, leading to the breach of some debt indicators (see DSA Annex).

A01ufig8

Micronesia: Net Oil Imports and International Prices

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: FSM authorities; and Bloomberg.1/ Simple average of Brent, Dubai, and WTI.

23. Impact of lower oil price. The FSM is a net importer of petroleum products, thus benefitting from a recent decline in energy prices. Micronesia’s net import of petroleum products have been increasing over the past two decades, rising from 4 percent of GDP in FY1995 to 12 percent in FY2013. This has partly reflected the increase in oil prices while changes in the way of life of Micronesians have led to a gradual shift to use of modern forms of energy. A decline in oil prices is expected to have positive impact as the FSM is a net oil importer – a 10 percent decline in the imported price of petroleum products is estimated to improve the current account balance by around 1 percent of GDP11. To reduce its reliance on imported petroleum products, the FSM has started to work with development partners to invest in renewable energy, in particular in outlying islands where the cost of electricity generation tends to be elevated.

A01ufig9

Micronesia: Fish Exports and Prices 1/

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

1/ Four-quarter moving average.Sources: Country authorities; Globe Fish, Ministry of Trade of Thailand; and Fund staff estimates.

24. Real exchange rate. Micronesia’s real exchange rate has been evolving in line with its neighboring countries in the Pacific, and is driven by changes in the price of imported food and fuel. The real effective rate appreciated by 5 percent between 2010 and 2013, before stabilizing in 2014 (Figure 2), but does not seem to have had much impact on Micronesia’s export that is heavily concentrated on tuna fish (see Box 3 on the fisheries sector). Fish export increased from 7 percent of GDP in FY2010 to 9 percent of GDP in FY2013, reflecting the increase in the international price of tuna.

25. Authorities’ view. The authorities broadly shared the view that lower oil prices would have some positive impact on the economy. They also noted that utilities companies have already started to lower the electricity tariff to pass on the lower price of imported diesel. The authorities mentioned that the use of the U.S. dollar as the domestic currency remains appropriate for the FSM given its limited administrative capacity for independent monetary and exchange rate policies.

E. Other Issues

26. Statistics. Improving the reliability, coverage, and timeliness of economics statistics is critically important to better guide policies. Staff notes ongoing efforts by authorities to improve data collection and management, including by the Office of Statistics, Budget and Economic Management, Overseas Development Assistance, and Compact Management (SBOC) and the Banking Board. Micronesia has started reporting to the Fund fiscal data using the Government Finance Statistics Manual 2001 (GFSM 2001) format since FY2013. Annual balance of payments and international investment position statistics are also reported to the Fund since 2014. The authorities are encouraged to further build statistical capacity, drawing on TA provided by the Statistical Department of the Fund and PFTAC.

Staff Appraisal

27. Outlook. Medium-term growth prospects in the FSM remain weak as the private sector remains sluggish while fiscal challenges loom ahead, in particular, the expiration of Compact grants in FY2023. However, policy actions included in the “2023 Action Plan” can strengthen the economic prospects of the FSM, if they can be implemented by achieving countrywide consensus across the national and four state governments.

28. Fiscal policy. The authorities should formulate a realistic medium-term fiscal framework that covers both the national and state governments, with a view to achieving budgetary self-reliance in the post-2023 period. The outstanding value of the trust funds in FY2023 should be used as the fiscal anchor to guide policy actions, including the implementation of the long-debated tax reform package and the extension of the LTFF to the national government; the transfer of fiscal surplus to the trust funds; and the widening of the URA coverage to the remaining two state governments. Fiscal consolidation efforts should be accompanied by improvement in the quality of public spending, so as to safeguard priority spending in the social sector and infrastructure investment with high development impact. The infrastructure development plan of 2004 should be updated as soon as possible to help expedite the release of Compact funds for infrastructure projects.

29. Private sector. Improving the investment climate is key to achieving private sector-led growth in the FSM. Growth-enhancing policy actions need to be undertaken, including addressing land tenure issues by expediting the land survey and registration, and facilitating foreign direct investment while paying particular attention to safeguard the cultural heritage and pristine nature of the country.

30. Financial sector. The commercial banking sector is sound with adequate capital and ample liquidity. Staff welcomes the authorities’ efforts to strengthen the regulatory framework of credit unions, including by preparing a new Credit Union Act to place them under the supervision of the Banking Board.

31. External sector. Risks to external stability are currently limited because the current account deficits are financed by official grants. The use of the U.S. dollar as the official currency remains appropriate given the small size of the economy and its close financial and trade linkages with the United States.

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

Micronesia: The “2023 Action Plan” and Its Economic Growth Strategy

Context. The FSM is facing fiscal and economic challenges as grants from the United States under the Compact of Free Association will expire in 2023 while investment returns from the trust funds (Compact Trust Fund and the FSM Trust Fund) are expected to be insufficient to replace them. The Strategic Development Plan of 2004-2023, while comprehensive in the coverage of planned policy actions, has not materialized in most part and the average real growth rate between 2004 and 2013 is disappointing at -0.4 percent.

2023 Planning Committee. In March 2012, the authorities established the “2023 Planning Committee”. Composed of the President and the four state Governors, with the secretariat provided by the national government (SBOC: Office of Statistics, Budget and Economic Management, Overseas Development Assistance, and Compact Management). Since the draft Action Plan was unveiled in November 2014, an extensive public awareness campaign has been launched to get a nationwide support, including in places outside of the country (e.g., Guam and Hawaii) where there is a large Micronesian community.

Scope and timeline. At the core of the Action Plan is the strengthening of the private sector while reducing reliance on the public sector as a driver of economic growth. In this context, the Action Plan aims at achieving a medium-term growth rate of 2 percent per year once all the proposed action plans are implemented, with the endorsement of the national and state legislatures. To this end, the Action Plan envisages policy actions in the following three areas: i) growth through structural reforms; ii) revenue mobilization (tax reforms to generate additional revenue of 4 percent of GDP); and iii) expenditure control (public administration reforms to have the expenditures track inflation levels). While the Action Plan has a time-bound results-based management matrix, a number of its policy actions, in particular, those in the fiscal and regulatory areas, require legislative measures. Achieving consensus in a nation with a loosely federated structure will be the key for the implementation of policy actions.

Key components of the economic growth strategy under the 2023 Action Plan

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Source: FSM authorities

Micronesia: Long-term Outlook on Trust Funds

Context. Micronesia has two trust funds to better prepare for the post-2023 period: The Compact Trust Fund (CTF) 1 which is jointly managed by the US and the FSM; and the FSM Trust Fund which is managed by the national government. In FY2014, CTF had a balance of $381 million (120 percent of GDP) whereas the FSM Trust Fund had a balance of $33 million (11 percent of GDP). Returns from the trust funds have been volatile. In FY2008, CTF net return was negative 19 percent, substantially eroding the market value of the fund. It experienced further negative returns in FY2009 and 2011, while gains in FY2010 reached 13 percent. Average return between FY2012–14 was 12 percent, offsetting negative performances in FY2008, FY2009 and FY2011.

A01ufig10

Micronesia: Compact Trust Fund

(US Million Dollars)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Source: FSM authorities.

Scenarios: Two scenarios are considered to assess the long-term outlook and the implications for the FSM’s fiscal sustainability. Long-term self-sufficiency is assumed to be achieved if after FY2023 the CTF, together with the FSM Trust Fund, can generate enough investment income to cover the reduction in Compact grants without eroding the real value of the trust funds.

Baseline Scenario

This scenario follows the assumptions adopted in the main text and the baseline in the DSA annex. Main assumptions include: a fiscal surplus of 2–3 percent of GDP until FY2023 on account of sustained fishing license fee revenue and some restraints on expenditures; half of the surplus will be transferred to the trust funds; and medium-term real GDP growth of 0.6 percent. Investment returns from the trust funds are assumed to average 6 percent, consistent with previous staff analysis. This is slightly higher than the average return (5.3 percent) since the CTF inception in 2004, which reflects the impact of unusually dismal earnings during the Global Financial Crisis.

A01ufig11

Micronesia: Consolidated General Government Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: FSMauthorities and Fund staff estimates.

Under the baseline scenario, investment returns from the trust funds in FY2024 (18 percent of GDP) will not be sufficient to cover the reduction in grants. While fiscal consolidation efforts by the state governments under the Long Term Fiscal Frameworks (LTFF) help constrain the expenditures, the fiscal balance of the general government will turn into a deficit of 1 percent of GDP in FY2024. The baseline assumes that the fiscal consolidation efforts are extended to the national government. This will result in smaller deficit in later years, resulting in a balanced budget in FY2034. Nominal amount of annual draw-downs from the trust funds will remain the same as in FY2024 ($70 million) – however, due to modest inflation, its real value as measured in percent of GDP will gradually decline (from 18 percent of GDP in FY2024 to 14 percent of GDP in FY2034). The real value of the trust funds balance will also decline (from 300 percent of GDP in FY2024 to 240 percent of GDP in FY2034), while their nominal amount will remain the same. In the meantime, the financing gap is assumed to be covered by additional borrowing on concessional terms to maintain priority spending in public infrastructure and social services with high development impact.

Policy Action Scenario

Under the policy action scenario, the authorities are assumed to undertake reforms to enhance economic growth and consolidate the fiscal balance. Medium-term growth rate rises by 1 percent per year from the baseline (from 0.6 to 1.6 percent). The tax reform package is implemented gradually between FY2016 and 2019, resulting in an increase of tax revenue by 4 percent of GDP in FY2019 and onwards. In addition to the fiscal consolidation efforts by the state governments under the LTFF, the policy action scenario assumes expenditure contraction by 1 percent of GDP. The entire fiscal surplus is transferred to the trust funds.

The trust funds balance will reach close to 340 percent of GDP in FY2023, generating sufficient investment returns to avoid fiscal deficit from FY20242. With the view to keeping essential services of the Government, this scenario assumes that draw-downs from the trust funds are adjusted annually by the inflation rate (about 2 percent per year). The balance of the trust funds will remain above 300 percent throughout the projection period while the public debt will remain on a sustainable path on account of stronger fiscal balance and accelerated growth (see the DSA Appendix). This shows again the critical importance for the authorities to achieve a national consensus in a loosely federated nation – the key to implement policy actions contained in the 2023 Action Plan, in particular, growth-enhancing structural reforms and the long-debated tax reform package.

A01ufig12

Micronesia: Trust Funds Asset Value

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: FSM authorities and Fund staff estimates.
A01ufig13

Micronesia: Trust Funds Asset Nominal Balance

(US Million Dollars)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Sources: FSM authorities and Fund staff estimates.
1 The CTF was created to contribute to the long-term budgetary self-reliance of the FSM and provide the FSM 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 FSM.2 If the assumed investment return drops from 6 to 5 percent, the trust funds balance in FY2023 will decline to about 310 percent of GDP. Lifting the trust funds value back to about 340 percent of GDP in FY2023 will require additional fiscal consolidation of 3 percent of GDP per year compared to the Policy Action Scenario. Generating the same amount of return in FY2024 as in the Policy Action Plan will require additional fiscal consolidation of 10 percent of GDP per year compared to the Policy Action Scenario (trust funds value in FY2023 will reach 400 percent of GDP).

Micronesia: Fisheries Sector in the FSM Economy

Context. Micronesian seas are rich in fish resources, in particular, skipjack, yellowfin, and bigeye tuna. FSM’s Exclusive Economic Zone (EEZ) covers an area of about 3 million square kilometers, close to the size of India. Fisheries sector is one of the pillars underpinning the economic growth strategy under the 2023 Action Plan. While employment in the sector is relatively small (2 percent of the total employment), fish export has been growing on account of rising international price of tuna and dominates Micronesia’s exports (more than 85 percent of total exports of goods if excluding re-exports of petroleum products for foreign aircrafts refuelling at Micronesia’s airports).

Subsectors. Fisheries in Micronesia can be categorized in 3 subsectors: i) subsistence fishery (mostly for home consumption and employment is informal); ii) locally-based commercial fishery (coastal and offshore); and iii) foreign-based offshore fishery. While the first two subsectors contribute directly to the GDP of the FSM (about 10 percent of GDP in total), the third subsector (foreign-based offshore fishery) contributes to the economy by way of paying fishing license fees to the National government.

Locally-based commercial fishery. Five fishing companies are incorporated in the FSM: two are relatively small and domestically-owned (wholly and minority-partially owned by state governments), two joint ventures (each 75 percent owned by Japanese companies), and one Chinese flagged company based in the FSM. Efforts to build locally-owned fishing industry have so far been disappointing on account mostly of lack of knowledge on international fish markets and low managerial capacities. Requirements for large upfront capital investment have also been an obstacle. Currently, the contribution to the development of the private sector and employment remains low, with formal employment in the fishing sector at less than 2 percent of total employment.

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Micronesia: Employment in Fishing Industry

(In percent of total employment)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

Foreign-based offshore fishery. Foreign-based vessels fishing in the Micronesian EEZ, mostly from China, Japan, South Korea, Taiwan, Province of China, and the U.S, pay fishing license fees to the national government. The fees are determined under the provisions in the Nauru Agreement1, a regional agreement that introduced in 2012 minimum benchmark fees for foreign fishing companies operating in the region. Under this system, fishing companies pay a flat fee per vessel per day with adjustment for the size of the vessel (VDS: Vessels Day Scheme). Minimum benchmark fees under the vessel day scheme (VDS) rose from $5,000 a day in FY2012 to $6,000 in FY2014 and most recently to $8,000 in FY2015 – a sign that the regional agreement has enhanced the bargaining powers of the signatory countries. While fishing license fee revenue has so far been increasing in tandem with the upward revision of the benchmark fees under the VDS, uncertainties loom ahead as the recent plunge in the price of tuna (from the peak of $2,520 per ton in the third quarter of 2012 to $1,670 per ton in the fourth quarter of 2014) has started to have some impacts on foreign fishing companies that send their vessels to the EEZ of Micronesia. Also, changes in the climate, including the El Niño cycle, could affect fish movement in the Pacific. In FY2014, revenue from the fishing license fees was $47 million (15 percent of GDP), accounting for 22 percent of the general government revenue. Authorities assume that the fishing license fee revenue will remain at the same level in the coming years.

Future prospects. While the authorities see potentials in the fishery sector, they recognize the difficulty in building their own fishing industry as opposed to foreign fishing companies that are better connected to the international tuna markets with well-equipped vessels. In this context, they are pursuing to obtain more value added from foreign vessels operating in the region rather than making more investment in domestic fishing companies: more transshipment of fish and vessel servicing at Micronesian ports. The planned ADB-financed Pohnpei Port development project that envisages expanding the wharf to cater to larger and more vessels will play an important role in this respect. Also, the authorities are considering introducing lower fees for those foreign fishing companies that make investment in the FSM for processing their fish catches in the Micronesian EEZ.

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Micronesia: Fishing License Fees

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

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Price of Tuna1

(U.S. dollars per ton)

Citation: IMF Staff Country Reports 2015, 128; 10.5089/9781513565026.002.A001

1/ Four-quarter moving average.Sources: Globe Fish, Ministry of Trade of Thailand; and IMF staff estimates.
1 “Nauru Agreement Concerning Cooperation in the Management of Fisheries of Common Interest” is a regional agreement between 8 signatories (PNA: Parties to the Nauru Agreement): FSM, Kiribati, Marshal Islands, Nauru, Palau, Papua New Guinea, Solomon Islands and Tuvalu.
Table 1.

Micronesia: Selected Economic Indicators, FY2010–15 1/

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Sources: FSM authorities and IMF staff estimates.

Fiscal year ending September 30.

Excludes grants to the Compact Trust Fund.

Government and public enterprise debt only.

Calendar year. 2003=100.

Table 2.

Micronesia: General Government Operations, FY2010–20 1/

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Sources: FSM authorities and IMF staff estimates.

Fiscal year ending September. The consolidated fiscal accounts cover the national and four state governments.

Excludes grants for the Compact Trust Fund.

Table 3.

Micronesia: Indicators of Financial and External Vulnerability, FY2010–20

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Sources: FSM authorities and IMF staff estimates.

Domestic bank. Data for FY2014 are as of December 31, 2014.

Data for FY2014 are estimate.

Most of the debt is concessional and to official lenders, of which about 2/3 is to the Asian Development Bank.

Table 4.

Micronesia: Deposit Money Banks, FY2010–14

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Sources: FSM authorities and IMF staff estimates.

Includes loans to abroad.

Calendar year average

Average rates offered by the deposit money banks

Average rates charged by the deposit money banks

Table 5.

Micronesia: Balance of Payments, FY2010–20

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Sources: FSM authorities and IMF staff estimates.

Includes household remittance and corporate tax on income from abroad.

Table 6.

Micronesia: Medium-Term Scenario, FY2013–25

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Sources: FSM authorities and IMF staff estimates.

Excludes contributions to the Compact Trust Fund.

Government and public enterprise debts only.