Abstract
On behalf of the Maldivian authorities, we would like to thank Mr. Kinda and his entire team for a constructive and effective Article IV consultation as well as for candid policy discussions. The authorities look forward to continuing their close engagement with the Fund, and highly appreciate the IMF’s valuable policy advice and technical assistance.
On behalf of the Maldivian authorities, we would like to thank Mr. Kinda and his entire team for a constructive and effective Article IV consultation as well as for candid policy discussions. The authorities look forward to continuing their close engagement with the Fund, and highly appreciate the IMF’s valuable policy advice and technical assistance.
Recent Economic Developments & Outlook
Although the pandemic took a significant toll on the Maldivian economy, the economic recovery from the COVID-19 shock has exceeded expectations with an impressive 41.7 percent growth rate in 2021 and an expected growth rate estimated at above 12 percent in 2022 underpinned by a strong rebound in tourism. In addition, the easing of COVID-19 containment measures led to a strong growth in the transportation communication, construction, and wholesale and retail trade sectors. As an economy that is also heavily import-dependent, Maldives is now facing inflationary pressures as supply chain challenges and geopolitical tensions continue to exert upward pressure on food and energy costs. So far, the pass through from global oil prices to domestic prices was contained owing to the government policies, including energy subsidies to maintain low electricity prices. However, these policies are putting significant pressure on public finances, and as a result, the authorities are planning to reform the subsidies and make them more targeted.
The COVID-19 pandemic was the largest shock to ever hit the Maldives’ economy and resulted in a historical GDP contraction of 33.5 percent1, one of the sharpest economic declines in the world. The social and economic impact of the crisis were devastating, with thousands of livelihoods affected by the shutdown of tourism and construction activities during the lockdown in 2020. Decisive and timely policies2 to mitigate the health and economic effects of the COVID-19 pandemic on the most vulnerable have allowed Maldives to quickly rebound. The emergency financing received from the Fund under the Rapid Credit Facility, and to some degree the debt suspension from official bilateral creditors under the G20 Debt Service Suspension Initiative, were also helpful in redirecting resources to more pressing needs.
As a small island state vulnerable to external shocks, the authorities are cognizant of the challenging global economic conditions in particular the downside risks emanating from the conflict in Ukraine, the global commodity price hikes, and the tightening of global monetary conditions. The authorities are more optimistic than staff about the growth outlook and expect that the recovery will gain more momentum in 2023. They are optimistic about the resilience of the tourism sector which has a diversified set of source countries, and due to its strong performance despite the conflict in Ukraine and the closure of the Chinese market. Going forward, the authorities expect a stronger growth momentum due to the significant upside risk from the reopening of the Chinese market in addition to the growth impact of some important projects. These projects include the Velana International Airport Development project, which is expected to increase tourist arrival capacity and help address the primary bottleneck in expanding the economy, as airport capacity has been one of the significant bottlenecks in expanding tourism industry, and cater for a significant demand from airlines, in addition to the Maldives International Port Project, and the Greater Male connectivity bridge project. It also includes projects to develop the agricultural sector, improve food security, ensure access to clean drinking water and sanitation in all the islands by 2023, as well as a high-speed ferry network which is expected to be completed by 2024. Tourism arrivals are expected to reach 1.6 million in 2022 and have already surpassed the total tourist arrivals recorded in 2021 by the end of October 2022. In 2023, tourism arrivals are expected to reach 1.8 million, surpassing the record set in 2019. In the absence of further shocks, the economy is expected to reach pre-Covid levels in 2023. Nevertheless, the authorities will remain vigilant amid the global uncertainties and are committed to prudent macroeconomic policies, rebuilding macroeconomic buffers, and safeguarding macroeconomic stability, as well as enhancing the resilience of the economy.
Fiscal Policy and Reforms
Despite limited policy space, the authorities deployed a prompt and comprehensive set of policy responses to help mitigate the socio-economic impact of the pandemic. Increase in health and social spending to support the vulnerable—including through electricity and water discounts, income support allowance, tax deferrals and food assistance— together with the sharp decline in revenues due to the pandemic resulted in a further deterioration of the fiscal position. Public finances are under pressure and expenditures are expected to be higher than budgeted in 2022 on the back of higher spending on fuel subsidies as a result of the spike in global commodity prices, as well as faster than expected rollout of public sector investment projects.
The authorities have initiated important reforms and developed an ambitious fiscal consolidation plan to rein in fiscal deficits and put public debt on a sustainable path and are committed to implementing it. The 2023 Budget, which is currently under discussion by parliament, has been formulated in this regard with the adjustment measures coming equally from revenues and expenditures (3 percent of GDP respectively). It is worth noting that this will be the first budget since the Covid-19 pandemic where recurrent expenditures will be managed within Government revenues excluding grants. To mobilize revenues, the authorities have increased the General Goods and Services Tax (GST) from 6 to 8 percent and the Tourism Goods and Services Tax (TGST) rate from 12 to 16 percent. The bill has been approved by parliament on November 16 and will be implemented starting January 1st, 2023. In addition, they plan to improve tax compliance as enforcement actions suspended due to the pandemic are now being implemented again and reduce the stock of tax arrears that has accumulated during the pandemic. On the expenditures side, measures include reducing fuel and electricity subsidies, introducing baseline prices for pharmaceuticals and bulk procurement for medical consumables and implementing the public salary harmonization in stages, which will target the health sector professionals in 2023. The GST rate change is expected to have a direct and indirect impact on prices estimated at around 2.5 percent, however, this will be a one-off price hike in goods and services.
The Medium-Term Fiscal Strategy 2023-20253 rightly focuses on managing fiscal risks and formulating a sustainable fiscal policy in the medium term. Fiscal consolidation will target the inefficiencies in government subsidy schemes, by introducing targeted subsidies. Significant progress has been made in managing public investment execution to achieve greater transparency, with the support of the World Bank, USAID and ADB. The authorities remain committed to improving the fiscal framework by further enhancing oversight of SOEs4 and moving forward with a better designed Fiscal Responsibility Act, which is being currently drafted in line with IMF recommendations and which will be submitted to parliament in February 2023. The authorities will continue focusing on updating the PFM roadmap and updating the legal framework including that related to debt management. They are grateful, in this regard, for the extensive IMF support and technical assistance being provided to reform energy subsidies and develop a medium-term revenue strategy5 as well as providing advice on reforms in tax policy. The authorities are also working on revising the current GST act, which is expected to be completed during 2023.
Debt Sustainability Assessment -The authorities continue to believe that the “Low-Income Country Debt Sustainability Framework (LICDSF)” needs to be adapted for a country with the special circumstances of the Maldives. While most of the Maldives’ debt stock is at highly concessional rates, the authorities have been proactively managing to address upcoming rollover risks in 2026. Moreover, and unlike most of the countries in the LICDSF, the Maldives has access to international financial markets. In the fiscal strategy, the government has committed to obtain foreign financing by relying primarily on concessional financing from bilateral or multilateral sources. As the cost of issuing debt from the international debt capital markets is expected to be high during these times, the revised financing strategy does not include issuances of conventional bonds in international markets prior to 2025. Moreover, the authorities are strengthening the sovereign development fund (SDF) established in 2016 to mitigate the rollover risk. Fund TA to support their efforts has been requested. As the economy recovers, the debt-to-GDP will improve with fiscal consolidation measures in place and strong GDP growth expected in the medium term. Finally, the government remains in a comfortable position to honor all its debt obligations.
Monetary Policy and Financial Stability
The Maldives Monetary Authority (MMA) has continued its strong track record of skillful management of monetary and financial policy. The MMA was proactive in implementing policy measures6 to mitigate the financial and economic disruptions arising from the COVID-19 pandemic and the global challenges, while supporting economic activity and maintaining price stability. As a final step in unwinding COVID-related banking sector support measures, the authorities have reverted the FX MRR back to 10 percent in October 2022. MMA continues to closely coordinate, together with the MoF, SOEs’ access to FX for essential needs. The MMA has recently developed a package of measures to reform FX markets and plans to roll it out gradually7. In order to ensure an adequate FX buffer, the MMA continues to maintain bilateral liquidity arrangements with other central banks8.
The MMA continues to ensure that the financial sector is sound and resilient and has a strong and effective prudential and supervisory framework at its disposal. The banking system remains stable even as pandemic-related financial sector support measures have elapsed. Capital and liquidity buffers are ample while nonperforming loans are gradually declining as the economy emerges from the pandemic. Moreover, the MMA’s banking sector stress tests reveal that banking sector buffers, notably the high capital adequacy ratio, remain strong against possible shocks arising from credit quality deteriorations, liquidity strains, and sovereign stress. In order to ensure a stable financial system, the MMA continued to formulate and issue regulations that would protect the financial system. The authorities have requested an FSAP to be conducted in 2023. They are also preparing to conduct a national risk assessment for AML/FT expected to be completed by the first quarter of 2023. The MMA authorities will continue to diligently monitor incoming macroeconomic and financial sector data and stand ready to make necessary adjustments to their policy instruments and intervention strategy, should the need arise.
Promoting financial inclusion remains a key priority of the MMA in its function of fostering the development of the financial sector, as it can increase prosperity and reduce regional wealth disparities in the country. The MMA continued the work on formulating the National Financial Inclusion Strategy for the Maldives, and a demand-side survey to gather the necessary data for formulating the nation-wide strategy has been completed and the report is expected to be soon published.
Sustainable Development & Building Resilience to Climate Change
The authorities have reprioritized the sustainable development goals to reflect urgent developmental needs following the pandemic. While the Maldives ranks better than peers in poverty and inequality, the authorities are aware that more efforts are needed to ensure inclusive growth. With most Maldivians dependent on tourism and fisheries for their livelihoods, the World Bank estimates that the poverty rate increased to 19.8 percent in 2020 due to the impact of the pandemic but is expected to drop to 3.8 percent with the economic rebound by the end of 2022. The government’s Strategic Action Plan (2019-23) focuses on decentralization, economic diversification through expanding the fisheries and agricultural sectors, SMEs, labor, employment and migration, social protection, and governance, among others. Many reforms are aimed at enhancing the role of the private sector and boosting competitiveness while supporting inclusive growth.
Addressing the Maldives’ exposure to natural disasters and climate change remains a priority that highlights the need for well-planned climate-change adaptation investments. Climate change is an existential threat to the Maldives, as over 80 percent of the land is under threat from rising sea levels and over 64 percent of the islands are reporting severe erosion. The additional challenges associated with the country’s dispersed geography include difficult service delivery and limited opportunities for job creation and economic diversification. The authorities have adopted a Climate Emergency Act on April 29, 2021, which introduces guidelines for addressing issues related to climate change, ensures the sustainability of natural resources, and sets out plans to achieve net-zero carbon emissions by 2030.
As a climate vulnerable nation facing multiple challenges with limited resources, the authorities have emphasized the need to secure grants and concessional financing to address climate needs in a sustainable manner and to reach net zero emissions by 2030. The authorities stressed the urgent need for more climate funding and indicated that climate financing for the Maldives is offered at the same market rates as conventional instruments, with additional climate mitigating conditionalities, which does not make for a meaningful alternative among the financing choices. The authorities expressed the need for Fund assistance to secure concessional climate finance and capacity development to facilitate the process of access to climate change financing as they have concerns regarding the lengthy requirements and formalities leading to low access to climate funds.
Conclusion
The past three years have presented unprecedented challenges for the Maldives. Amid elevated global uncertainties, the Maldivian authorities will remain vigilant over global developments and assess how these could affect macroeconomic and financial stability. They remain committed to their fiscal strategy and economic reforms and look forward to continuing to closely work with staff on addressing macroeconomic challenges.
To contain the spread of the virus, the country closed its borders for the first time in history, between March 27 and July 15, 2020, leading to a sudden stop in tourism - the main driver of growth, jobs, and revenues.
The authorities spent significant fiscal resources to deal with the impact of the COVID-19 pandemic, by adopting a “COVID-19 Health and Social Response” and an “Economic Relief Package”, totaling around 6 percent of GDP to protect businesses, jobs and incomes. Measures included assistance to 1.5 million vulnerable households, social transfers to assist the unemployed and independent workers, and tax deferrals to households and firms.
To support fiscal sustainability, the authorities also developed their medium-term fiscal strategy along four anchors: (i) reducing public debt excluding guarantees to less than 100 percent of GDP by 2025, (ii) reducing the primary budget deficit to less than 5 percent of GDP by 2023, (iii) maintaining public debt as a share to GDP on a downward trend, and (iv) reducing recurrent expenditure to levels that do not exceed government revenue by 2023.
Mechanisms and guidelines have been enhanced, including standardizing the SOEs procurement guidelines, publishing information of large procurements on the Ministry of Finance website, publishing information on small procurements by government agencies on the government gazette, adjusting public finance regulations to facilitate bid protesting mechanism and independent review, and publishing information on ongoing and planned public investments projects.
Along with IMF and SARTTAC, WB and ADB are also assisting us in developing the Medium-Term Revenue Strategy.
These include: (i) reduction of the minimum required reserves (RR) up to 5 percent as and when required; (ii) making available a short-term credit facility to financial institutions as and when required; (iii) introducing regulatory measures to enable a moratorium on loan repayments. Moreover, the MMA intervened at the beginning of the crisis, actively providing liquidity support to the banking sector to mitigate adverse economic impacts.
These include regulating licensing criteria and conditions for money changers, encouraging the use of the Maldivian Rufiyaa in domestic monetary transactions, and limiting the types of transactions allowed through FX accounts.
The foreign exchange swap agreement under the existing 2019-2022 South Asian Association for Regional Cooperation (SAARC) framework, has been extended through June 30, 2023.