Maldives: 2005 Article IV Consultation—Public Information Notice; Staff Report; and Statement by the Executive Director for Maldives

2005 Article IV Consultation-Public Information Notice; Staff Report; and Statement by the Executive Director for Maldives

Abstract

2005 Article IV Consultation-Public Information Notice; Staff Report; and Statement by the Executive Director for Maldives

I. Introduction and Background

1. The Maldives suffered devastating damage from the tsunami in December 2004.1 Physical damage relative to the size of the economy was the highest among affected countries and livelihood was severely disrupted—including displacement of 5 percent of population. The cost of reconstructing housing and infrastructure is estimated at $375 million (about 50 percent of GDP), and private tourist resorts sustained damages amounting to $100 million (largely covered by insurance). However, the damage in Male was less severe and key productive assets and infrastructure in the capital region were largely spared.

2. The serious economic consequences of the tsunami are evident. Real GDP is estimated to have contracted by 3¾ percent in 2005, as tourist arrivals fell by 33 percent. With the decline in tourism, foreign exchange earnings have plummeted, and an overall balance of payments deficit of $140 million is projected for 2005—exacerbated by higher oil prices (Figure 1, Table 1). The fiscal balance for 2005 worsened as tourism revenues dropped while new initiatives were taken to provide power and water subsidies and increase (untargeted) social sector spending. Even though the government decided to limit administrative spending and increase revenue collection during the last quarter of the year, financing from the Maldives Monetary Authority (MMA) amounted to 9 percent of GDP (Figure 2). Tourist arrivals started to recover strongly toward the end of 2005 as most tourist resorts reopened, and real GDP is expected to rebound in 2006. But significant fiscal and external gaps are still projected.

Figure 1.
Figure 1.

Maldives: Real and External Sector Developments, 1995–2005

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

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

Maldives: Selected Economic Indicators, 2001–06

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

GNFS = Goods and nonfactor services.

Includes additional external financing, assuming equal proportions of grants and loans.

Domestic exports are defined as merchandise exports net of reexports.

Figure 2.
Figure 2.

Maldives: Fiscal and Monetary Sector Developments, 1995–2005

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

Sources: Maldivian authorities; and IMF staff estimates.

3. Reconstruction work proceeded slowly in 2005 because of implementation difficulties and, for some sectors, inadequate donor support.2,3 Aid amounting to $260 million has been pledged so far, but disbursements and reconstruction were initially slow due to problems in local consultation, limited capacity, and insufficient coordination. Measures have been taken to address them and reconstruction work has started to accelerate (Box 1). To fully reconstruct infrastructure, however, additional donor commitments of around $100 million are still needed—especially in sectors such as transport and water and sanitation.

Progress in Tsunami Recovery

Many recovery projects remain unfunded. Donors have so far pledged to finance around 70 percent of estimated recovery costs ($375 million). Water, transportation, and power projects are particularly underfunded.

Implementation was initially slow even in areas with donor funding. As of October 2005, 18 percent of donor pledges (or about 6 percent of GDP) has been disbursed. About half of internally displaced people still live in temporary shelters and tents and more than 30 percent are doubling up with others.

Implementation of Tsunami Recovery Projects

(As of October 31, 2005)

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Source: Maldives Ministry of Planning and National Development.

These delays were caused by prolonged community consultation, problems in the tender process, inadequate local capacity, and insufficient coordination. Residents’ psychological attachment to their islands complicated implementation of projects involving relocation. Tenders have been time consuming because results can be revoked if any party complains about the outcome. Engineers and project managers are in short supply. There is also scope for improving donor coordination and clarifying responsibilities within the government.

The government and donors have taken measures to accelerate implementation. The government has started to devolve project implementation to local authorities, which has proven effective in expediting housing reconstruction. Tender processes are being reviewed, and donors have provided project managers and site engineers. Workshops have been conducted to improve donor coordination, and, to improve monitoring, development data systems are being installed with UN assistance. As a result, the pace of reconstruction has started to accelerate.

The budgetary impact of recovery efforts is hard to measure as it depends on the pace of implementation and disbursement of donor funds. In addition, it is hard to capture donors’ direct payments and some donors operate outside the budget framework. With these caveats, recorded budgetary reconstruction spending as of October 2005 was Rf 300–400 million (3 percent of GDP) including a government contribution of 1 percent of GDP. The government estimates that the total recovery efforts in 2005 should amount to over 10 percent of GDP. In the 2006 budget, donor funding of recovery efforts is expected to be about Rf 2.4 billion or 20 percent of GDP. In addition, the government contribution included in the budget is 1–2 percent of GDP.

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Financing Gaps of Tsunami Recovery Projects

(% of Total Needs, as of October 31, 2005)

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

Source: Maldives Ministry of Finance and Treasury

4. Furthermore, donors’ efforts to provide budget support have been impeded by insufficiently tight fiscal policy. The World Bank and the Asian Development Bank (AsDB) are considering extending budget support totaling nearly $40 million (of which about half could be disbursed in 2006) provided a sound fiscal framework is reestablished. In the event, however, the 2006 budget adopted immediately after the conclusion of the Article IV mission is much more expansionary than envisaged or discussed with the mission; both the World Bank and AsDB are urging the authorities to recommit to a prudent policy.

5. These developments have taken place against a backdrop of ongoing reforms to introduce multiparty democracy. A longstanding ban on political parties was lifted in June 2005, and the government announced that democratic multiparty elections would be held soon. But consensus has not been reached on the pace of implementing these reforms and there have been confrontations between security forces and the opposition. In this environment, the government appears to be proceeding cautiously in adjusting fiscal policy in response to emerging revenue shortfalls and financing constraints.

II. Stocktaking and Recent Developments

6. The Maldives achieved high real GDP growth over the decade up until the tsunami based on expanding tourism. The tourism sector contributed nearly half of the growth, with fisheries activity, reflecting recent private participation, also contributing. Meanwhile, the dollar peg provided the Maldives with a stable nominal anchor generally helping to preserve external competitiveness. As a result, income per capita grew by 60 percent over the decade (through 2004) to above $2,500, and social indicators improved significantly.4

Maldives: Developments in 1995–2004

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Real Effective Exchange Rates

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

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Structure of the Economy

(% of GDP)

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

Source: Maldives Ministry of Planning and National Development

7. However, the economy has remained vulnerable to external shocks due to its undiversified production, small size, as well as geography––as demonstrated in the tsunami and its aftermath. The narrow production and export base—tourism and fisheries— is highly vulnerable to external shocks and the scope of policy response is correspondingly limited.5 At the same time, global warming and rising sea levels pose a long-term threat.

8. Macroeconomic management has generally been sound, but fiscal performance has fluctuated with external conditions and spending slippages. The authorities increased revenues by 9–10 percentage points of GDP over the last decade through higher tourism revenues and state-owned enterprise (SOE) transfers. Although current expenditure rose slightly faster, domestic financing of the budget was kept manageable largely through restraint on capital spending, and foreign financing. However, the government’s capacity to respond to adverse shocks through timely fiscal adjustment is limited. Revenues are inflexible in the short run (the “bed” tax is nominally fixed per overnight stay of a tourist, and resort lease payments and SOE transfers are pre-determined for each budget), and expenditures tend to be rigid downward.6 During 1999–2001, a combination of spending slippages and a global tourism slowdown led to high recourse to MMA borrowing and a currency devaluation in 2001.

9. During 2003–04, growth remained strong with improved fiscal performance. Real GDP growth averaged 8 percent over 2003–04 while nonfood inflation was stable. The fiscal deficit declined and was largely financed by concessional foreign borrowing. Robust revenues associated with buoyant tourism contributed to this improvement. This performance was only partially offset by a 40 percent rise in civil servants’ wages in September 2004, the first adjustment in five years that more than offset the real wage erosion since the last adjustment. The original 2005 budget also envisaged practically no domestic financing––the higher wage bill was to be financed by enhanced revenues.

10. With the tsunami, however, the fiscal situation deteriorated dramatically. The supplementary budget prepared in August 2005 envisaged a budget deficit (including foreign grants) of Rf 1.6 billion (15 percent of GDP)—up from 4 percent of GDP in the original budget—and a domestic financing requirement of 12 percent of GDP. Because of the tsunami, tourism-related revenues declined by 4 percent of GDP and new revenue measures included in the original budget (2 percent of GDP) were not implemented.7 On the spending side, domestic contributions to higher relief and recovery outlays and newly announced initiatives each added 2 percent of GDP to the fiscal deficit. Recognizing the risk associated with such an expansionary stance, the authorities started to take action during the last quarter of the year, and saved about 3 percent of GDP mainly by reducing administrative expenditures. This, however, still left an estimated deficit of 12 percent of GDP with MMA borrowing of 9 percent of GDP (Table 3).8

Table 2.

Maldives: Balance of Payments, 2001–06

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

Domestic exports are defined as merchandise exports net of reexports.

GNFS = Goods and nonfactor services.

Includes additional external financing, assuming equal proportions of grants and loans.

Table 3.

Maldives: Central Government Finance, 2001–06

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

2005 Fiscal Developments

(In millions of rufiyaa)

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Source: Ministry of Finance and Treasury.

11. High domestic financing of the budget notwithstanding, inflation has been subdued as private domestic currency lending was modest.9 In particular, foreign-owned commercial banks borrowed about $100 million from their headquarters abroad and on-lent the funds largely to tourist resorts, which in turn used the proceeds for importing reconstruction materials.10 Thus, while government borrowing surged, total domestic currency lending was more limited and inflation has remained well below 5 percent (year-on-year) (Table 4).

Table 4.

Maldives: Summary of Monetary Accounts and MMA Balance Sheet, 2001–05

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates.

12. More generally, monetary policy has been passive with the MMA automatically financing the fiscal deficit. The authorities introduced tap sales of MMA CDs in 1995, liberalized interest rates (except for a 20 percent ceiling on lending rates) in 2001, and lowered the minimum reserve requirement (MRR) from 35 percent to 30 percent in 2003 in line with Fund advice. They are now preparing for the introduction of indirect monetary management. But these steps have not led to proactive policy implementation. The MMA has continued its automatic financing of the fiscal deficit; the MRR has remained at 30 percent; and tap sales of MMA CDs continue with a fixed interest rate of 4 percent regardless of the level of market liquidity. Commercial bank interest rates have also remained broadly unchanged since mid-2002 reflecting limited competition and underdeveloped links with external markets. The amended MMA Act (drafted in 2003) to make the central bank independent of the government and set limits to government borrowing was recently withdrawn from the parliament for further revision.11

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Current Account in the Maldives

(in millions of U.S. dollars)

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

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Financial Inflows

(in millions of U.S. dollars)

Citation: IMF Staff Country Reports 2019, 281; 10.5089/9781513512457.002.A001

13. Commercial bank borrowing from abroad helped reduce the balance of payments gap. With a $160 million decline in tourism receipts and high oil import prices, the current account deficit for 2005 is estimated to have been a record high $300 million (37 percent of GDP). But commercial banks’ borrowing from foreign headquarters, primarily to finance reconstruction, covered a large portion of total import needs, and the reserve loss was limited to about $20 million (Table 2). Official reserves at end-2005 amounted to $187 million (2½ months of imports).

14. The pace of structural reforms has lagged. The authorities have embarked on several structural reform initiatives—fiscal, SOE, and financial sector reforms—to create a business environment conducive to private investment and to support diversified growth. Progress has, however, been slow due in part to limited implementation capacity, and more recently to the tsunami disaster (Box 2). In the fiscal area, the Business Profit Tax (BPT) Act is yet to be enacted despite lengthy parliamentary debate, and preparations for the introduction of the sales tax and a medium–term expenditure framework (MTEF) did not progress last year. On privatization, past efforts notwithstanding, SOEs continue to operate in key areas that in most countries are left to the private sector (for example, tourism, trade, insurance, and communications). A number of key legislations (including acts on public enterprises, banking, securities, and customs administration in addition to the amendment of the MMA Act) are at different stages of preparation––but progress has generally been slow.

Structural Reform Agenda and Status

The authorities’ major structural reform agenda comprise the following.

  • Fiscal Reforms. Revenues are to be enhanced through introduction of a BPT and a sales tax, and by improved customs administration. The BPT Act is being debated in the parliament. Collection of about 3 percent of GDP is to start by 2008 although the mission recommended earlier implementation. The authorities also intend to prepare a broad-based sales tax to replace a large portion of import duties, but its timetable remains unclear. The Customs Administration Act, also in the parliament, will establish sound customs procedures. On expenditures, the MTEF, prepared with World Bank/AsDB assistance, should set multiyear resource envelopes based on realistic revenue projections and ensure that expenditure decisions will be guided by strategic goals. The authorities intend to introduce the MTEF in 2010 and have taken few concrete actions lately. The Public Finance Act was enacted in December without the provision for limiting government access to MMA borrowing.

  • Civil Service. A parliamentarian submitted the Public Service Bill (approval expected mid-2006). The bill will create a civil service commission which determines civil service size and salaries and recruits civil servants. In addition, a pension reform is considered with World Bank assistance although no concrete action has been taken so far.

  • Public Enterprises. No firm has been privatized since 2001 due in part to a concern over its perceived negative revenue impact. The government plans to sell shares of Allied Insurance, Housing Development and Finance Corporation, and Water and Sewerage Company in 2006, and gradually proceed with further privatization/corporatization. The preparation of a Public Enterprise Act has been delayed due to disagreements over whether line ministries or the finance ministry should control SOEs.

  • The Financial Sector. On-site examinations of three major banks have been completed with MFD assistance. Efforts to make the MMA independent of the government continue, but the amendment to the MMA Act (drafted in late 2003) was temporarily withdrawn from the parliament for revision due to disagreements on the role of government officials on the MMA’s Board. The Banking and Securities Acts were drafted in early 2005 and will be submitted to the parliament in 2006. Insurance legislations are also under preparation.

  • Foreign Trade. The Export and Import Act assigns control of rates/coverage to Finance Ministry while Trade Ministry is to retain regulatory power. The Act also will remove duty waivers on imports related to resort construction and fisheries. To stimulate regional trade, South Asian Free Trade Agreement (SAFTA) rules of origin have been lowered to 40 percent value addition with further 10 percent derogation for lower income members. Lower-income SAFTA members including the Maldives are to reduce tariffs to 0–5 percent in 10 years.

III. Policy Discussions

15. Discussions focused on: steps to address the large fiscal deficit that emerged after the tsunami; monetary policy reforms towards an indirect management system; and the medium term outlook and structural reforms that could help sustain robust and broad-based growth.

A. Macroeconomic Policies for 2006

Fiscal policy

16. The mission underlined the need to restore fiscal discipline in 2006, with a view to limiting domestic financing to less than 3 percent of GDP. At the time of the mission, the authorities broadly agreed and expressed their intention to strengthen revenues while lowering spending significantly. On the revenue side, they intended to implement the measures originally proposed in the 2005 budget and also to largely eliminate import duty exemptions. They also expected higher resort lease payments due both to increases in lease rates and advance lease payments expected from winners of tenders of five new resort islands.12 On expenditures, the government intended to limit domestic spending to the original 2005 budget level except for the following two adjustments: (i) an increase in the wage bill due to internal promotions and new recruits mostly in education, health, police, and national security (amounting to 3 percent of GDP); and (ii) elimination of power, water, and food subsidies (saving 2 percent of GDP). If these intentions were implemented, the domestic financing requirement could be slightly less than 3 percent of GDP.

17. In the event, the government adopted a 2006 budget that includes significantly higher spending. While details of this increase (about 7 percent of GDP) are not yet available, it appears to include an even higher wage bill and additional health and education spending that is not tsunami related. Allocations for domestic investment projects, not donor-funded, have also increased significantly.13 In addition, there is a significant risk to the budget as it does not provide for a subsidy to a main power company, which would require tariff increases that are not decided.14

2006 Fiscal Developments

(In millions of rufiyaa)

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Source: Ministry of Finance and Treasury.

18. Proposed measures to finance this higher spending appear unrealistic and large domestic borrowing may emerge, threatening macroeconomic stability. The higher spending is to be funded largely by advance lease payments (amounting to 4½ percent of GDP) paid by winners of tenders of 35 new resort islands along with additional budget support from bilateral donors (3 percent of GDP). However, given experience to date, it is considered difficult to complete 35 island tenders and collect advance lease payments within one year. Assumed donor support also appears optimistic.15 With shortfalls likely in both revenue and foreign financing, government borrowing from the MMA could exceed 9 percent of GDP. This level of MMA borrowing, following a similar amount in 2005, could precipitate significant inflationary pressure and/or losses in foreign reserves. The authorities recognize the risks associated with this budget and are designing contingency remedial measures (primarily identifying expenditures that could be cut or delayed). These measures, if announced in time, will be reported to Executive Directors through a staff supplement.

19. The mission stressed the importance of improving fiscal management by enhancing revenues and prioritizing spending through introduction of the MTEF and civil service reforms. On enhancing revenues, the mission welcomed the authorities’ plan to introduce a BPT in 2008 and prepare a sales tax for subsequent implementation. Given the current fiscal difficulties, the mission stressed that it would be desirable to accelerate implementation of this plan and also to adjust the specific tourist “bed” tax more frequently with a view to turning it into an ad valorem tax. On the expenditure side, an early introduction of the MTEF for capital spending—prioritizing projects according to agreed criteria such as cost-benefit calculations—would likely improve expenditure management significantly. Similarly, there is a need to limit general administration expenses and streamline the public service through implementing civil service reforms—civil servants are 10 percent of the population and their wage bill is 20 percent of GDP. Expeditious enactment of the Public Finance Act and the Audit Act designed to improve public sector management is also important.

20. The authorities reaffirmed their commitment to improved fiscal management but thought careful preparation was needed. The authorities stated that most of the measures suggested by staff were already elements of their reform strategy, but did not commit to accelerated implementation stressing the need for careful preparation. On civil service reforms, the authorities had no specific plan, but pointed out that a parliamentarian had tabled a Public Service Act that would establish a civil service commission. The mission urged the authorities to be more proactive and request donors’ technical assistance for designing reforms that could enhance civil service effectiveness while containing its cost. Finally, the Public Finance Act was approved at the end of December. While this is welcome, the Act does not include the long-awaited provision for limiting government access to MMA borrowing. The authorities indicated that their plan now was to include the provision in an amended MMA Act.

Exchange rate regime

21. The dollar peg continues to be an appropriate exchange rate arrangement. The mission agreed with the authorities that the peg had reduced transaction costs and exchange rate risks, provided a transparent nominal anchor, and had been consistent with constrained institutional capacity to manage a foreign exchange market. Based on the movements of the real effective exchange rate and the strong recovery of tourism witnessed toward the end of 2005, the level of the exchange rate appears generally appropriate despite near double-digit inflation seen earlier in the year and concerns about possible foreign exchange shortages expressed by the business community. These concerns were dissipated with the strong recovery of tourist arrivals during the last quarter of the year, and there is no parallel market. If, however, the expansionary fiscal stance implied in the 2006 budget were to be sustained, inflationary pressures would likely mount and the peg rate could ultimately be jeopardized.

Monetary and banking sector policy

22. Automatic financing of fiscal deficits by the MMA should cease and monetary policy needs to focus on supporting the exchange rate peg. Important elements of such a strategy would be:

  • Expediting the adoption of the amended MMA Act which makes the monetary authority independent and sets legal limits to the government’s domestic borrowing (as the Public Finance Act excludes this provision).

  • Reducing the reserve requirement further to improve intermediation, continuing with development of a liquidity forecasting framework, auctioning MMA CDs, and eventually replacing the CDs with treasury bills.

  • MMA could in the meantime consider an adjustment of CD rates to absorb liquidity created by the government’s high domestic borrowing.

The authorities intend to implement these actions (with ongoing MFD technical assistance) although proceeding cautiously with regard to starting CD auctions or raising CD rates because of concerns about the impact of high interest rates on the weak economy.

23. Turning to the banking sector, the mission welcomed progress made in supervision. The MMA has continued on- and off-site inspections of commercial banks on a regular basis focused on improving risk management practices in these banks. These inspections have facilitated a decline and restructuring in nonperforming loans (NPLs).16 Even then, as commercial banks in the Maldives tend to have high concentration risk and increasing net open foreign exchange positions, the MMA should closely monitor developments. The authorities requested continued MFD technical assistance in this effort.

B. Medium-Term Outlook and Structural Reforms

24. A medium-term strategy in line with the stance adopted in the 2006 budget— with limited reform—would carry serious risks. The budget, announced after the mission’s departure from Male, is based on higher spending and more optimistic revenue levels than discussed during the mission. Table 5 presents a scenario that illustrates the possible outcome of such a policy approach. With revenues weaker than envisaged, official reserves would likely decline steadily implying the need for strong corrective actions down the road.

Table 5.

Maldives: Base Case Medium-Term Scenario, 2004–10

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

Based on the approved 2006 budget.

Includes state enterprise debt.

Domestic exports are defined as merchandise exports net of reexports.

The decline in exports in 2005 reflects the expiration of garment export privileges. Garments account for about one-fourth of merchandise exports. However, effects on the real economy are negligible since textile production yields little value added.

GNFS = Goods and nonfactor services.

Includes additional external financing, assuming equal proportions of grants and loans.

25. Achieving sustainable growth over the medium term remains a challenge even with prudent fiscal management and structural reform implementation. Discussions during the mission focused on an alternative medium-term scenario in which real GDP growth stabilizes at around 5 percent after a rebound in 2006 (Table 6). The mission stressed that achieving such an outcome in an environment of declining foreign aid would require prudent fiscal management and vigorous pursuit of structural reforms. To limit domestic borrowing to a sustainable level, a large fiscal adjustment would appear necessary—revenues need to be raised by 4–5 percentage points of GDP in five years and domestic recurrent spending lowered also by 4–5 percent. This would allow growth with low inflation while strong revenue efforts would allow current spending to be maintained at a level higher than before the tsunami. However, even with the large fiscal adjustment assumed in this scenario, official reserves are projected to increase minimally due largely to declining foreign aid and the need to amortize ongoing foreign borrowing by commercial banks.

Table 6.

Maldives: Reform Case Medium-Term Scenario, 2004–10

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

2006 figures are based on a policy scenario discussed during the Article IV mission.

Includes state enterprise debt.

Domestic exports are defined as merchandise exports net of reexports.

The decline in exports in 2005 reflects the expiration of garment export privileges. Garments account for about one-fourth of merchandise exports. However, effects on the real economy are negligible since textile production yields little value added.

GNFS = Goods and nonfactor services.

Includes additional external financing, assuming equal proportions of grants and loans.

Table 7.

Maldives: Indicators of External Vulnerability, 1991–2005

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Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.

The first entry is the average for 1995–96.

Adjusted for the exchange rate change in 2001.

GNFS = Goods and nonfactor services.

Domestic exports are defined as merchandise exports net of reexports.

26. The authorities agreed that structural reforms must be pursued vigorously in part to realize the private capital inflows assumed in the projection. Key reforms include public enterprise reforms and development of a sound economic and financial legal framework.

  • Renewed efforts are needed to privatize or corporatize public enterprises. The mission welcomed the authorities’ plan to sell shares of three SOEs in 2006 and urged the authorities to consider full privatization of entities directly competing with the private sector while completing corporatization of remaining SOEs. The authorities indicated that they would like to coordinate privatization exercises with introduction of a BPT to minimize possible revenue loss associated with privatization.

  • On economic and financial legislation, the authorities believe that significant progress can be made in 2006. Following delays due in part to the impact of the tsunami, they were ready to accelerate efforts in this area.

27. Debt sustainability would also be threatened by the expansionary fiscal stance of the newly approved budget. The Maldives’ external debt has increased to about 60 percent of GDP from 42 percent in 2004 as aid for tsunami recovery came partly in the form of loans and as foreign-owned commercial banks borrowed significantly from their overseas headquarters. A scenario based on the newly announced 2006 budget (Table 5) raises the fiscal debt-to-GDP ratio—and erode foreign reserves in the external analysis—to such levels that would likely call for abrupt corrective actions in the coming years (Tables 8 and 9). Sensitivity analyses indicate that the economy’s debt burden may increase even further in the event additional exogenous or policy induced shocks occur. A debt sustainability analyses—based on a prudent policy approach (Table 6) indicate that the debt-to-GDP ratio could stabilize over the medium term (Tables 10 and 11).

Table 8.

Maldives: Base Case External Debt Sustainability Framework, 2000–10 (In percent of GDP, unless otherwise indicated)

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Based on the Article IV mission discussion, figures for 2005 are preliminary estimates.

External debt is based upon the assumption that around 30 percent of private capital flows are debt-creating.

Derived as [r-g -ρ(l+g) + εα(l+r)]/(l+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt; p = change in domestic GDP deflator in U.S. dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domes tic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(l+g) + εα (l+r)]/(l+g+ρ+gρ) times previous period debt stock, p increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes price and exchange rate changes, as well as changes in foreign reserves.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both noninterest current account and nondebt inflows in percent of GDP.

The implied change in other key variables under this scenario is discussed in the text.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and both noninterest current account and nondebt inflows in percent of GDP) remain at their levels of the last projection year.

The sharp increase in external debt in 2005 is due in part to the rise of commercial bank borrowing from abroad.