Maldives: 2024 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Maldives
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
13 May 2024
eISBN:
9798400275920
Language:
English
Keywords:
headline inflation; MMA balance sheet; market share; MMA liability; private sector; Government debt management
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1. The Maldives’ economic recovery from COVID-19 pandemic has shown resilience.

Abstract

1. The Maldives’ economic recovery from COVID-19 pandemic has shown resilience.

Context

1. The Maldives’ economic recovery from COVID-19 pandemic has shown resilience.

Despite headwinds from Russia’s war in Ukraine, tourist arrivals have steadily increased and are set to reach a historic high in 2023. Amid a buoyant tourism sector, real GDP surpassed its pre-pandemic level in 2022. Nevertheless, economic scars remain, particularly related to losses in education opportunities1. Robust growth has also contributed to sustained poverty and inequality reduction, with poverty level2 falling to an estimate of about 1.5 percent of total population in 2023 from 3.9 percent in 2019.

A001fig1

Maldives: Economic Performance

(In percent, average over relevant period)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: MMA; ILO; World Bank's World Development Indicators; and IMF Staff Calculations and Estimates.

2. The cyclical rebound and still favorable economic outlook provide a narrow window of opportunity for the Maldives to fix its large fiscal and external imbalances. Over the years, sizeable infrastructure spending push and generous social assistance programs have led to a sharp rise in public debt. Large external financing requirements to support public spending have added pressures on external stability. This calls for immediate policy actions to tackle these long-standing vulnerabilities, importantly for the Maldives to rebuild its economic resilience, regain financial market access when needed, and avoid any forced disruptive adjustments. Being one of the lowest lying nations in the world, the Maldives’ vulnerability to natural disasters and climate change is paramount. Early actions to rein in debt vulnerabilities will help support the Maldives’ efforts to scale up the much-needed climate adaptation investments in a resource constrained context.

3. The new government is committed to restore macroeconomic stability, while sustaining growth. Past Fund policy advice gained traction, importantly the implementation of the tourism and domestic goods and services tax (TGST and GST respectively) rate hikes among others (Annex I). The current administration sees the urgency of reducing debt and putting public finances on a more sustainable footing. The Presidential address in February 2024 laid out fiscal adjustment measures, including subsidy reforms that phase out existing subsidies and replace them with targeted direct income transfers, healthcare reform, capital expenditure rationalization, and reforms of state-owned enterprises (SOEs), and the authorities are committed to urgently implement them. Given tourism sector’s dominant role in the Maldivian economy, the government prioritizes policies to further expand tourism activities, including to expedite the completion of Velana International Airport (VIA) terminal expansion. The government also emphasizes policies to reduce spatial disparities between Male and other atolls and support sustainable development.

Recent Developments

4. The Maldives’ post pandemic growth has been strong, but recently normalized. After a brief contraction of tourist arrivals following the war in Ukraine, the tourism sector was quickly back to a strong footing, benefited from the Maldives’ diversified source countries and China’s reopening at end-2022 (Text Figure 1). The economy grew by 13.9 percent in 2022, with the tourism sector contributing to about one third of real GDP growth. Tourist arrivals in 2023 reached a historic high of 1.88 million. Nevertheless, real GDP growth in 2023 is estimated to moderate to 4.4 percent. The airport terminal capacity constraints and increased diversification of tourist arrivals, shifting in part toward shorter stay and guesthouse-based travelers, despite their contribution to the overall increase in tourism revenue, led to growth slowdown (Box I).

Text Figure 1.
Text Figure 1.

Maldives: Tourist Arrivals and Economic Activity

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authority, Maldives Bureau of Statistics, and IMF Staff Calculations.

5. Inflation has been contained, amid price subsidies. Reflecting the base effect due to the GST rate hikes—effective in January 2023—and high commodity prices, headline inflation in Male rose in the first half of 2023, peaking at 3.8 percent year-on-year (y-o-y) in April. Nevertheless, vast existing price subsidies have limited the pass-through from GST rate hikes and global commodity price pressures to headline inflation. Helped by falling food and energy prices, Male inflation declined to 1.9 percent y-o-y in December 2023.

6. Fiscal vulnerabilities remain elevated. The successful implementation of GST rate hikes is estimated to yield tax revenue gains of about 3.2 percent of GDP in 20233. Nevertheless, the overall fiscal deficit is estimated to reach 13.4 percent of GDP in 2023, up from 7.8 percent of GDP envisaged in the initial budget. The widened fiscal deficit was due to spending pressures from significant increases in capital spending, rising interest costs amid increased debt stock and tight global financial conditions, increased subsidies related to medical services, fuel and electricity, and election-related expenditure. Support to state-owned enterprises (SOEs) are also added risks to fiscal sustainability, as they often require large and ad-hoc budget support to address their solvency and liquidity issues (Annex IV).

7. Public debt rose further. Total public and publicly guaranteed (PPG) debt is estimated to increase to MVR 122 billion, about 118.7 percent of GDP in 2023. While robust recovery in tourism and growth has helped suppress debt-to-GDP ratio in recent years, gross financing needs are substantial, due to large fiscal deficits and increased debt services repayments. Amid limited access to external financing, rising fiscal financing needs are being met by domestic debt issuance and monetary financing, with bank financing through purchases of government securities continued to underpin most of domestic financing in 2023. The authorities discontinued monetary financing at the end of 2023 and securitized the outstanding Maldives Monetary Authority (MMA) advances into 30-to-40-year government bonds in early 2022, then February and December 2023, with face values of MVR 2.5 billion, 4.4 billion, and 1.9 billion, respectively.

A001fig3

Maldives: Central Bank Fiscal Financing

(In billions of MVR) 16

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Maldives Monetary Authority.

8. The current account deficit sharply widened. Despite robust tourism revenues, the current account deficit is estimated to further deteriorate to 22.8 percent of GDP in 2023, due to surging capital goods imports, high import costs of food and fuel, and strong import demands associated with tourism activity. This has led to persistent foreign exchange (FX) shortages with significant spread of around 10-15 percent between the official and parallel market rates. Real effective exchange rate marginally appreciated in the first eight months of 2023, and stayed well above its long-term historical average. Gross international reserves steadily declined to US$589 million at end-December 2023, covering about 1.4 months of prospective imports. The overall external position in 2023 is assessed to be substantially weaker than the level implied by fundamentals and desirable policies, which urgently requires upfront fiscal consolidation to contain external financing needs and rebuild FX reserve buffers to reduce vulnerabilities and risks (Annex II).

Outlook and Risks

9. Growth is projected at 5.2 percent in 2024 (Table 1-5). Tourist arrivals are expected to rise further and the authorities forecast 2 million tourist arrivals for 2024. The resilience in the tourism sector and associated spillovers to other sectors will continue to drive economic activity, although the pace is moderating. The VIA terminal expansion and associated increase in hotel accommodation capacities is projected to further boost growth potential, upon the expected completion in 20254 and over the medium term. The planned phasing out of subsidies is expected to add inflationary pressures, with inflation projected to rise to 3.8 percent in 2024 then gradually decline to 3 percent in 2025.

10. Despite reform measures to recurrent expenditure, fiscal sustainability without additional strong policy measures will remain at risk. Long-standing subsidy reforms are expected to take off in July 2024, which entails phasing out subsidies on fuel, electricity, and food staples by end of the year and rolling out direct income transfers targeting vulnerable households. Rationalization on health insurance scheme, Aasandha, and other medical expenditures, which encompasses facilitating bulk procurement to generate cost savings and imposing revised coverage prices, is expected to be implemented in the latter half of 2024. Complete enactment of the expected subsidy and medical expenditure reforms will help reduce total fiscal expenditure by 1.9 percent of GDP in 2024. The overall fiscal deficit is projected to narrow marginally to 12.2 percent of GDP in 2024, and public debt would stay above 110 percent of GDP over the medium term. Without policy changes, SOEs are expected to remain vulnerable, as liquidity and solvency risks persist.

11. The external sustainability hinges critically on fiscal adjustments. Given high commodity prices and continued public investment, imports of food, fuel, and capital goods will weigh on trade balance, leading to persistently high current account deficit of 19.4 percent of GDP in 2024. While the completion of airport terminal expansion will help ease up import demands, the expected rise in external debt services payments and profit remittance associated with FDI will continue to weigh on the current account balance to remain at around 10 percent of GDP over the medium term. In absence of corrective policies, FX reserves are projected to remain suppressed in the near term, covering about 1 month of prospective imports, before gradually rising over the medium term.

12. Debt vulnerability persists. The joint IMF-World Bank Debt Sustainability Analysis (DSA) assesses that, without significant policy changes, the Maldives remains at high risk of external and overall debt distress, and protracted breaches in several debt indicators over the medium term make the assessment of debt unsustainable. Gross external financing needs are expected to rise in the coming years, reflecting persistently large fiscal deficits and repayments and rollovers of nonconcessional debt, mainly global sukuk. External refinancing pressures are expected to peak in 2026. Increasingly higher amortizations and large interest payments would trigger protracted breaches in several debt indicators by 2026, similar to the previous DSA. The debt dynamics will remain vulnerable to adverse shocks in growth, interest rates, and fiscal position in the near term.

13. Uncertainty surrounding the outlook remains high and risks are tilted to the downside (Annex III). Delayed fiscal consolidation and failure to reduce public debt will risk economic stability. Weaker growth in key source markets for Maldives' tourism could adversely affect tourism revenue, with spillovers on to the rest of the economy. In particular, as China is expected to remain one of the largest tourist source markets for the Maldives, growth could be weighed down by China's structural deceleration, which may lower Chinese tourist arrivals in the medium term (Box II). A renewed uptick in global energy and food prices could widen current account deficit, further drawn on the already-thin FX reserve buffers. Tighter global financial conditions could add to interest costs and reduce options for market financing to the government. The Maldives is highly vulnerable to climate change risks, with potentially severe economic costs due to floods and rising sea level.

Authorities' Views

14. The authorities broadly agreed with staff’s assessment on the outlook and risks and highlighted several upside risks. They concurred that the return to normal growth rates was faster than anticipated, supported by the expansion of new source markets and connectivity despite some compositional changes in tourists’ average stay and spending preferences. The authorities emphasized that the guesthouse sector is a segmented market and could help diversify the products offered by the tourism industry. At the same time, they underscored several upside risks to the tourism sector outlook. First, the new terminal of VIA could be operational sooner-than-expected, thus augmenting the airport capacity to accommodate tourists considerably in the near term. Second, diversification of resorts and guesthouses offerings can appeal to tourists with different preferences when the bottleneck on airport capacity is lifted, which will further expand tourism revenue. Third, upside risks to the outlook of key source markets (e.g., China) could help generate additional revenue in the tourism sector.

Key Policy Issues

Comprehensive policy reforms will be paramount to urgently reduce fiscal vulnerabilities, stem rising balance of payments pressures, and safeguard financial stability, while supporting sustained strong and inclusive growth.

15. Policy mix. With limited policy space and growing balance of payments pressures, the authorities should swiftly implement front-loaded fiscal adjustments, accompanied by tighter monetary and macroprudential policies, to reduce vulnerabilities, restore sustainability of public finances, and lessen FX pressures. This will help avoid disruptive adjustments and lay the foundation for strong, inclusive, and sustainable growth.

  • Under staff’s baseline scenario (Table 1-5), which reflects the authorities’ established policies and implementations of some expenditure reforms5, elevated near-term fiscal spending push will continue to put substantial pressures on the domestic economy and the current account. In the face of a prolonged period of over-expansionary macroeconomic policy mix, limited access to market financing has been followed by declining official financing. The resulting decline in FX reserves would continue to weigh on economic stability and confidence, crowd out private investment to support growth, expose macro-financial risks, and risk disruptive adjustments down the road.

  • Under staff's proposed policy adjustment scenario (Text Table 1), public spending is further scaled back, while domestic revenue mobilization continues to progress, and monetary policy is tightened. These measures would promote economic stability and address the overall macroeconomic risks by limiting further public debt creation, containing the current account deficit, thus rebuilding FX reserves to more sustainable levels. Adopting macroprudential policies to rein in sovereign-bank nexus would also help limit financial sector risks. Although near-term growth is slightly more measured in this scenario, a prudent policy stance and the stronger external balance of payments would reduce macroeconomic risks and provide a sounder basis for sustained strong growth in the medium-term.

Text Table 1.

Maldives: Medium-Term Macro-Fiscal Outlook

(In percent of GDP, unless otherwise indicated)

article image
Source: IMF Staff Projections. 1/ The policy adjustment scenario assumes a fiscal multiplier of 0.2, in line with literatures on small islands states that suggest a relatively low fiscal multipliers (see, for instance, Dodzin and Bai (2016), Alichi and others (2021) and Balasundharam and others (2023).

A. Fiscal Policy

16. The successful implementation of GST rate increases is a welcome step, but additional strong and credible form of fiscal consolidation will be needed. The authorities' homegrown revenue mobilization plan that stems from GST rate hikes has borne fruit, bringing sizable revenue windfalls in 2023. The authorities' medium-term fiscal strategy (MTFS) for 2024-2026 has laudable anchors, including (i) reducing public debt to less than 95 percent of GDP by 2026, (ii) reducing primary budget deficit to less than 5 percent of GDP by 2024, (iii) maintaining PPG debt-to-GDP ratio on a downward trend, and (iv) reducing recurrent expenditure to levels that do not exceed government revenue by 2024. The 2024 budget envisages the implementation of fuel and electricity subsidy reforms in the second half of 2024, after a delay from initial announcement in January 2023, as well as some reduction in capital expenditure. Nevertheless, in staff's view, the fiscal consolidation plan envisaged under the current policies will not be sufficient to achieve these ambitious targets. The following discussion (A17-fl20) lays out a set of recommended fiscal adjustments aiming for faster debt reduction to increase the chance of meeting such targets. To increase the chance of meeting these targets, this critically requires swift implementation of a strong and credible form of fiscal consolidation that comprises both expenditure rationalization and domestic revenue mobilization, while avoiding political temptation to spend and borrow more.

17. Holistic expenditure rationalization is a priority to narrow fiscal deficit and bring debt down.

  • Subsidy reforms should be implemented without further delay. The 2024 budget presents a reform plan to phase out fuel, electricity, and other existing subsidies and replace them with targeted cash transfers toward low-income households, which will be implemented starting in the second half of 2024. The authorities, with the help from the World Bank, are developing a direct cash transfer mechanism that emphasizes on the vulnerable population. In the policy adjustment scenario, efforts to further rationalize and streamline health subsidies6, Aasandha, could be adopted.

  • Rationalizing capital spending. The authorities should heavily reprioritize, rationalize, and scale back capital spending, including through SOEs. Staff's analysis suggests that the Maldives' capital spending push since 2014 appears to have passed its peak economic gains, and at current high debt level, its incremental growth benefit has diminished. Hence, infrastructure development projects need to be realistically costed, appraised, and subject to transparent and rigorous project selection process for inclusion in the annual budget. Enhancing fiscal institutions and the public financial framework would enable the authorities to conduct more effective project appraisals and costings. The authorities should safeguard capital expenditure that supports growth potential, while rationalizing projects that are costly but less essential.

A001fig4

Maldives: Public Investment and Future Real GDP Growth 1/

(In percent)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF Staff Estimates.1/ Correlation between public investment and future real GDP growth was positive when public debt was below 50 percent of GDP, but turned negative when public debt was above 50 percent of GDP. Data are from 1991 to 2019. Data for COVID-19 years are excluded, due to large volatility of real GDPgrowth rates.

  • Public wage and pension reforms. The continuation of pay harmonization measures, which aim to raise compensation of all public servants, is expected to add an additional MVR 3 billion (2 percent of GDP) to total government expenditure by 2026. Comprehensively reviewing the public sector wage bill and assessing the target for pay harmonization in the context of both civil service efficiency and budget sustainability is necessary to address fiscal spending pressures. This should be followed by measures to reduce unnecessary cost associated with pay harmonization in order to mitigate fiscal burden. In addition, the new pension schemes covering the public sector and state-owned enterprises are proliferated, fragmented, and costly. Early actions to streamline such schemes and phase out overly generous, tax-financed pension benefits will help reduce pension expenditures in the long term.

  • SOE reforms are warranted to reduce additional fiscal burdens caused by SOE vulnerabilities (Annex IV). As identified by IMF technical assistance (TA), the authorities should undertake reforms to address these risks in a strategic manner, including to triage SOE portfolio, then restructure weak SOEs to ensure their financial viability and reduce the number of SOEs, particularly those either non-commercial in their operations or do not have sufficient operations to justify being classified as an SOE. In addition, reforms to develop new SOE legislation, strengthen fiscal risk and oversight framework, and improve performance management of SOEs are critical.

18. Further domestic revenue mobilization would help ensure fiscal sustainability. The medium-term revenue strategy (MTRS) presents options for revenue mobilization, including to lower the personal income tax (PIT)7 thresholds and personal allowance, raise the top marginal PIT rate, increase the statutory rate of corporate income tax, rationalize import duty exemptions, apply excises on tobacco, fuels, alcoholic products, and motor vehicles, and impose carbon levy on fuels. Adopting additional measures to raise tax revenues, along with strengthening customs and tax administration, would yield sustained fiscal savings to increase the probability of approaching and achieving fiscal and debt sustainability.

19. Strengthening fiscal institutions and the public financial framework is critical to enhance the credibility and effectiveness of fiscal policy. IMF's Public Investment Management Assessment (PIMA) identified several weaknesses in public investment and financial management, importantly related to budget credibility and budget execution. In this regard, infrastructure development projects need to be realistically costed, appraised, and subject to transparent and rigorous project selection process for inclusion in the annual budget. Enhancing fiscal institutions and the public financial framework would enable the authorities to conduct more effective project appraisals and costings. In particular, reforms to develop a strategic and focused Public Sector Investment Program (PSIP) and a costed medium-term national development strategy should be expedited. The authorities should strengthen strategic guidance and budget ceilings for public investment, in line with the fiscal strategy statement. A ceiling for the PSIP budget included in the budget circular at the start of the budget process based on a binding resource envelope should be respected.

20. Improving debt management will help better manage financial costs and reduce debt-related risks. The authorities should urgently develop a realistic and credible multi-year debt management strategy to systemically reduce rollover and solvency risks. Finalizing the Public Debt Management Law and completing the reform of the Fiscal Responsibility Act (FRA) should be part of a broader credible plan that puts debt on a sustainable path, including by setting and disclosing realistic numerical targets for the fiscal deficit and public debt in a subsequent Charter of Fiscal Responsibility to support compliance and accountability. Rising interest burdens could be limited by avoiding non-concessional financing of non-priority spending, particularly capital spending. Deepening domestic debt markets would not only help release resources for priority spending, but also broaden investor base and reduce foreign currency risks. The authorities are taking a welcome step to develop a law for the sovereign development fund (SDF), in which it could earmark the airport development fee for crediting to the SDF along with one-off windfall revenues from resort leases, privatization proceeds, among others. The accumulation and investment of SDF in FX instruments that match the loan portfolio will also help manage external debt or servicing such debt. Given imminent climate change vulnerability to the Maldives, the authorities may continue to explore innovative financing options such as debt-for-nature swaps as part of an overall fiscal strategy.

Authorities' Views

21. The authorities emphasized their readiness to undertake the necessary fiscal adjustments. They stressed that subsidy reforms will be executed from July 2024, and the preparatory work is underway while collaborating with various stakeholders. They instructed the line ministries to reprioritize the investment projects under PSIP, by appraising benefits over costs and ensuring future revenue generation. Nevertheless, the authorities cautioned against trade-offs of the impending fiscal consolidation measures, as miscalibration of subsidies reforms and capital expenditure rationalization could induce unintended growth and welfare impacts. The authorities also agreed that SOE reforms are warranted to reduce additional fiscal burdens, arising from SOE vulnerabilities. In this regard, the cabinet has endorsed an SOE reform plan, and the authorities are currently developing the reform plans for individual SOEs to ensure operational efficiency and financial viability. They underscored strengthening coordination with domestic stakeholders and multilateral donors could help pave the way for the successful implementation of fiscal policy adjustments. The authorities also highlighted that the recent resumption of the accumulation of inflows to the SDF in foreign currency would increase the debt servicing capacity in the future.

B. Monetary and Exchange Rate Policies

22. Excess structural liquidity continues to pose risks to economic stability. The peg to U.S. dollar continues to serve as a transparent nominal anchor for monetary policy. Nevertheless, the current stance of monetary policy is too accommodative, where increased MMA advances and subsequent securitization of monetary financing have translated into central bank liquidity injection and large excess structural liquidity in the system (about 7 percent of GDP or 8.1 percent of banking system's assets). The size and conditions of the past and recent securitization of MMA advances to the Government of Maldives have compromised the MMA balance sheet and impacted the MMA's ability to conduct an independent and active liquidity management to support the exchange rate peg.

A001fig5

Maldives: Net Foreign Exchange Assets and Excess Liquidity 1/

(In millions of MVR)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Maldives Monetary Authority.1/ Excess liquidity refers to bank deposits in excess of required reserves at the central bank.

23. Monetary policy, in concertation with other policy levers, can contribute more effectively to addressing macroeconomic vulnerabilities. Discontinuing exceptional use of MMA advances based on a temporary suspension of limits on MMA advances under the FRA is a welcome first step. 8 Raising minimum reserve requirements (MRR) rate on Rufiyaa, while ensuring policy coordination between monetary and fiscal policies, would help absorbing some excess liquidity and signal monetary tightening.9 Going forward, more active liquidity management in domestic currency would be needed, in which MMA could rely on periodic open market operations (OMOs) to steer interest rate on commercial banks' liquidity toward an appropriate level within the interest rate corridor given by Standing Deposit and Lending Facility interest rates. Should inflationary pressures increase or the parallel market exchange rate premium widen, MMA should stand ready to further tighten monetary policy stance. In line with IMF TA, it is recommended that the MMA gradually undertakes liquidity absorbing operation to address excess structural liquidity resulted from the securitized monetary financing, initially with a maturity of one-year.

24. Accelerating long-overdue reforms of FX markets, alongside the needed macroeconomic adjustments, will enhance the credibility of the peg. The MMA, under the 2017 MMA's FX-Intervention Policy, provides weekly allocation to commercial banks based on their foreign currency asset position and net open position for import payments and telegraphic transfers payments. In addition, the MMA, through banks, provides FX allocations to Maldivians traveling abroad for medical and education purposes and provides a maximum of US$500 per person/trip in cash for Maldivian traveling abroad, as well as to SOEs, mainly for foreign loans obligations, import payments of fuel. The rationing of foreign exchange and its allocation to certain priority items give rise to an exchange restriction10. The authorities are working on a comprehensive FX reform strategy through enhancing the use of Rufiyaa (e.g., for payrolls and transactions), promoting alternative financial instruments that are denominated in Rufiyaa and satiate risk appetites and liquidity preferences of large investors (e.g., SOEs), and streamlining licensing regulation on money changing businesses. The discussion with key stakeholders in the private and public sectors on the reform strategy should be expedited. The MMA should then apply the regulations on the use of the MVR as widely as possible including for all salaries and taxes. The new digital instant payment system will act as a facilitator to this process. An overhaul of the current system of money changer licenses should be directed toward channeling the FX supply through the domestic banking system.

Authorities' Views

25. The authorities agreed with the need to gradually tighten monetary policy, though it needs to be accompanied by fiscal consolidation to reduce external balance and FX pressures. The authorities noted that the temporary suspension of clauses 32 a), d) and e) of the Fiscal Responsibility Act (FRA) 2013 has expired at end-December 2023, effectively ending use of MMA advances to finance government deficits. As the first step to deal with the existing excess liquidity, the MMA considered gradually increasing MRR rate on Rufiyaa deposits to absorb up to MVR 1.5 billion of excess liquidity. They cautioned that OMOs could potentially complicate domestic financing through government securities in the near term. Over time, the MMA is looking into conducting structural/long-term OMOs to absorb the remaining excess liquidity and more regular OMOs afterward as needed. Since the MMA has not been conducting OMOs since 2014, it is seeking IMF TA on liquidity forecasting and on conducting OMOs to support such operations. The authorities also stressed on the need for close coordination between monetary and fiscal policies, especially during the rollout of the fiscal reforms.

26. The MMA underscored the peg continues to serve as an appropriate policy anchor, while recognizing challenges under conditions of limited foreign exchange reserves. The MMA continued to provide FX supply to commercial banks through its regular allocations prioritizing specific priority needs. Meanwhile, the MMA has developed a package of measures to reform FX markets and shared the draft with government for technical consultation. The measures 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 MMA noted that these reforms would help improve functioning of FX markets going forward.

C. Financial Sector Policies

27. Systemic risks have increased, stemming largely from a growing sovereign-bank nexus, high dollarization, and a shortage of foreign exchange (Text Figure 2 and Annex V). The overall banking sector remains sound, with high capital and liquidity buffers and strong profitability (Table 6). Credit to private sector continued to recover in line with tourism-related activity, and nonperforming loans ratio declined to a historic low of 5.2 percent of gross loans in September 2023. Nevertheless, macro-financial vulnerabilities in the Maldives primarily related to the sovereign-bank nexus have increased, where banking sector exposure to sovereign debt continues to rise above 30 percent of total assets, well above peer countries in the region, and sovereign exposure as share of total bank capital breaches 400 percent in some banks. The application of a zero risk-weight on domestic sovereign exposures has in part contributed to the banking sector's sizable sovereign exposures. Significant maturity mismatch also poses liquidity risk including from runs on callable foreign currency deposits. The Maldives' vulnerability to natural disasters and climate change could have repercussions on the financial sector in the longer run.

A001fig6

Banking Sector Sovereign Debt Holding to Total Asset Ratio

(In percent)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Haver Analytics; and IMF staff calculations.
Text Figure 2.
Text Figure 2.

Maldives: Macro-Financial Linkages of the Sovereign-Bank Nexus

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF Financial Sector Stability Assessment on the Maldives (2023).

28. Macroprudential policies should be adopted to mitigate systemic risks. As identified by the joint IMF-World Bank Financial Sector Assessment Program (FSAP), banks are found to be relatively resilient to economic shocks, thanks to ample interest margins. Nevertheless, an unraveling of the sovereign-bank nexus, where further stress on public finance could elevate sovereign risks leading to valuation losses on sovereign papers, would rapidly deplete bank capital. In this regard, the authorities plan to gradually phase in a 100 percent risk weight on bank holdings of Maldives government securities in foreign currency and introduce liquidity requirements. A macroprudential institutional framework and instruments should be swiftly introduced, and systemic risk monitoring capacity should be further strengthened (Table 7).

29. Financial sector oversight and crisis management need to be enhanced. Addressing weaknesses in the regulatory and supervisory frameworks through strengthening MMA independence, redefining off-site monitoring, and enhancing enforcement is crucial. With the help of IMF TA, MMA should perform a comprehensive review of the regulations and supervisory processes for loan loss provisioning with the focus on loan classifications and the transition to international financial reporting standards 9 (IFRS9). Improvements are also required in financial safety net and crisis management arrangements. Priorities include (i) making early intervention and resolution triggers forward-looking; (ii) introducing recovery and resolution planning; (iii) overhauling the use of public funds in resolution; and (iv) enhancing the deposit insurance system. An effective emergency liquidity assistance framework is needed to address challenges from the high dollarization and FX shortages. Interagency arrangements and crisis preparedness should also be strengthened.

30. The authorities should swiftly address gaps in the legal framework and enhance implementation of the AML/CFT framework. The authorities are preparing for the Maldives' mutual evaluation by the Asia/Pacific Group on Money Laundering (APG), against the Financial Action Task Force (FATF) international standards on anti-money laundering and combatting the financing of terrorism (AML/CFT) in 2024-2025. The authorities' current and planned steps include mitigating risks identified in the national risk assessment (NRA), addressing gaps in the legal framework, issuing regulations for remaining sectors (e.g., payment service providers and financing businesses). The NRA's findings which were shared with the financial sector should enable it to factor these in their own institutional risk assessment and mitigation plans, including enhancing suspicious transactions reporting. Regulation of the financial sector and service providers needs to be improved, and supervision should be conducted on a risk-based approach, also to address risks related to non-resident inflows. Such reforms would assist the authorities to mitigate domestic and foreign ML/TF risks safeguarding the financial sector integrity and its cross-border business.

Authorities' Views

31. The authorities generally agreed with the FSAP findings and recommendations, including on the strong sovereign-bank nexus. They flagged some concerns about the recommended a 100 percent risk weight on domestic sovereign securities in foreign currency, likely making sourcing of FX from banks more difficult or costly. Therefore, the authorities agreed with the proposed gradual phasing-in of the risk weight over the medium term, while more details are being discussed with stakeholders. The authorities also mentioned that upcoming amendments to the AML framework would address technical deficiencies identified by FATF toward the upcoming mutual assessment in 2025.

D. Climate Change and Other Structural Reforms

32. The Maldives is highly vulnerable to the climate change and natural disasters. Climate change poses an existential threat to the low-lying islands of the Maldives through sea level rise and flood. The country is also vulnerable to ocean warming and resulting coral bleaching events, potentially affecting tourism activity over the longer term. The fiscal and climate vulnerabilities together have magnified posing significant risks to the economy, livelihoods, and food security, where the atolls outside of Male are particularly vulnerable.

A001fig8

Maldives: Exposure to Climate Change Index

Range 0-1, higher score means more vulnerable to climate change)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Notre Dame Global Adaption Initiative, 2021; and IMF staff calculations.

33. Given the Maldives’ climate vulnerabilities, strengthening institutions to support climate adaptation and mitigation efforts and mobilize climate finance is critical. The authorities set the ambitious goal of reducing emissions by 26 percent by 2030 through increased use of renewable energy sources, as articulated in the Nationally Determined Contribution (NDC). They have also started to take actions to reap benefits from a green and blue transition, such as developing a comprehensive set of development and climate policies and plans and initiating an ambitious infrastructure program prioritizing resilience11. In this regard, the integration of climate sensitivity into public financial management and public investment management processes can be a key contributor to government's strategies to combat the climate change (see Annex VI). Priority actions include the introduction of climate budget tagging and a Climate Budget Statement into the budget process alongside more in-depth periodic assessment of the fiscal costs and risks of climate change. The authorities could also provide a new guidance to the public sector on how to incorporate climate sensitivity into investment plans, with a stronger role for the Ministry of Finance and the Ministry of Climate Change, Environment and Energy. Adding climate dimensions to project appraisal and selection processes as well as systems for asset management and maintenance could be considered. Such policies will facilitate scaling-up of climate adaptation and additional climate finance from concessional sources.

34. Improving the business climate, strengthening governance and tackling corruption, and enhancing skill developments will help support strong and inclusive growth. Improvement in governance will reduce risks of corruption and cost of doing business, improve economic efficiency, and attract more FDI inflows. While the Maldives performs well relative to its South Asian peers on voice and accountability and rule of laws, there is room to further strengthen its regulatory quality (Figure 6). Asset Declaration Bill is being drafted to enhance the declaration process. The Anti-Corruption Commission has stepped up their efforts on their investigation activities under its strategic action plan 2020-2024. Policy priorities should include enhancing public disclosures of financial transactions of government and SOEs operations and strengthening the procurement procedures through the harmonization of procurement guidelines for SOEs and adopting a more competitive procurement process. Further efforts to align the legal framework of foreign investment to protect property rights, support FDI facilitation, and address skill gaps including through improving the quality of education and equal opportunity to education across gender will help boost investment, productivity and competitiveness.

35. IMF capacity development (CD) will continue to support the authorities’ efforts to expedite macro-critical reforms. The Maldives is one of the intensive IMF CD recipients amongst countries in Asia and the Pacific. CD priorities are closely aligned with IMF surveillance policy recommendations that include revenue mobilization, expenditure rationalization, public financial and debt management, financial sector reforms, and monetary and exchange rate policies (Annex VII).

Authorities' Views

36. The authorities have advanced its climate reform agenda. The authorities are developing the National Development Strategy that lays out the country’s 20-year development vision, which will include a new National Adaptation Plan (NAP) and associated implementation strategies. They are also committed to scaling up their mitigation efforts, by developing renewable energy systems, jointly with development partners, toward its COP28 commitment to expand renewables to reach 33 percent of the nation’s electrical supply within the next five years. In addition, the government has recently completed budget tagging for the Sustainable Development Goals (SDGs) and already begun work on climate budget tagging. This will be followed by a climate budget statement, which will incorporate the costs and risks of climate change into the budgeting process. The government is also working to formulate an environmental, social, and governance (ESG) framework. Given the immediate threats of climate change to the Maldives, the authorities highlighted the importance of greater and more flexible access to concessional climate financing, which has been either difficult to access due to strict procedural requirements, or limited as the access levels are constrained by the country’s quota or the size of the economy regardless of the extent of climate vulnerabilities and hence climate financing needs.

37. The authorities highlighted their strategy to expand trade and investment through diversification and competitiveness enhancement. The authorities underscored their continued efforts to further strengthen the tourism sector through enhancing overall capacity and diversified market segments within the sector. In addition, the authorities aim to increase the competitiveness of tuna fishery by modernizing it with new and environmental-friendly vessels. While sustainable pole and line tuna fishing in the Maldives has helped conserve ocean resources, this has weighed significant costs on the Maldivian tuna fishery as global tuna prices are not necessarily fair enough for such sustainable catches. The authorities are considering ways to garner preferential market access from key tuna exports markets toward sustainable fishery. The authorities noted that they would continue to improve governance, including by passing a draft bill on asset declaration, and to strengthen their asset recovery process with a new bill on asset recovery.

Staff Appraisal

38. The Maldives’ economy recovered strongly from COVID-19 pandemic but now faces challenges. Following the pandemic-induced contraction and strong post-COVID rebound, the Maldivian economy is estimated to have grown by 4.4 percent in 2023. Achieving projected growth of 5.2 percent in 2024 will require significant policy adjustments to address existing vulnerabilities. Inflation is expected to rise further, reflecting price pressures from the phasing-out of subsidies. Risks to the outlook are tilted to the downside.

39. Large fiscal and debt vulnerabilities persist. Without significant policy changes, the overall fiscal deficit is projected to narrow marginally but remain elevated at 12.2 percent of GDP in 2024. Continued support to SOEs is adding to fiscal vulnerabilities. Gross external financing needs are expected to rise in the coming years, reflecting persistently large fiscal deficits and repayments and rollovers of non-concessional debt, mainly global sukuk. The Maldives remains at high risk of external and overall debt distress, with debt assessed as unsustainable.

40. The external positions remain under pressures. Reflecting high import costs of food and fuel, and strong import demands associated with tourism activity and capital investment, large current account deficits would persist even over the medium term, weighing on FX reserves. The overall external position in 2023 is assessed to be substantially weaker than the level implied by fundamentals and desirable policies.

41. A strong and credible form of fiscal consolidation is urgently needed to reduce debt and restore the sustainability of public finances. Subsidy reforms should be implemented without delay and further efforts to rationalize and streamline healthcare subsidies could be subsequently adopted. The authorities should rationalize and scale back capital spending, including through SOEs. Assuming additional measures to mobilize domestic revenue, along with strengthening customs and tax administration, would help ensure fiscal sustainability. Strengthening fiscal and debt management is critical to enhance the effectiveness of fiscal policy.

42. Better fiscal-monetary policy coordination should facilitate necessary monetary policy actions to safeguard the exchange rate peg. Discontinued using of MMA advances is a welcome first step and should over time be complemented by a more active liquidity management. Should inflationary pressures increase or the parallel market exchange rate premium widen, the MMA should stand ready to further tighten monetary policy stance. FX market reforms should be accelerated to enhance the credibility of the peg. Fiscal adjustment will avoid renewed excessive burden on monetary policy.

43. Adopting macroprudential policies will help mitigate systemic risks stemming from the sovereign-bank nexus. The authorities should amend capital regulation to gradually phase in a non-zero risk weight on bank holdings of Maldives government securities in foreign currency and introduce liquidity requirements. Macroprudential institutional framework and instruments should be swiftly introduced, and systemic risk monitoring capacity could be further enhanced. Together with enhancing financial sector oversight and crisis management, the financial safety net needs to be strengthened. Addressing gaps in the legal framework and implementing the AML/CFT framework should also be prioritized.

44. Accelerating reforms to support inclusive and sustainable development remains crucial. Given the Maldives' climate vulnerabilities, reforms to integrate climate considerations into the public financial and investment management processes and frameworks will help support climate adaptation and mitigation efforts, and facilitate scaling-up of climate finance from concessional sources. Improving the business climate, strengthening governance and tackling corruption, and enhancing skill developments will help support strong, inclusive, and sustainable growth.

45. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Sectoral Analysis of Maldives’ Tourism Industry1

Resorts and guesthouses are the two largest segments in the Maldives’ tourism industry. While resorts are dominant segment in the tourism industry representing about 80 percent of total bednights, share of guesthouses, the second largest segment, has grown over time with notable increase in 2023 and reached almost 18 percent of total bednights (see text charts). Moreover, due to substantially lower night rates, the increasing share of guesthouses is associated with arrivals of lower-cost tourists.

A001fig9

Maldives: Tourist Accomodation by Type

(Bednights, in Millions)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authrity and IMF staff calculations.
A001fig10

Maldives: Tourism Sector Growth in Maldives

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authority; and IMF staff calculations.

Contribution of the guesthouses segment to the value added per one bednight is likely much smaller than contribution of the resorts. Based on estimates using seasonally adjusted quarterly tourism real GDP data and number of bednights for different segments, the average value added generated by one bednight in a guesthouse is about 15 percent of the average value added generated by one bednight in a resort.2 Considering the difference in value added together with the increase in number of guesthouses bednights in 2023, could explain lower-than-expected growth of the tourism sector GDP despite the solid growth in total bednights and tourist arrivals (see text chart).

A001fig11

Maldives: Tourism Sector GDP Growth 1/

(In percent, year-on-year)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authority; and IMF staff calculations and estimates.1/ Line charts represent actual tourism GDP growth outturns, and backcasted estimates of tourism GDP growth using aggregate bednights versus more detailed bednights by accommodation types.

Provided that tourist arrivals are expanding and the management of tourism segments are well-balanced, growth of the guesthouses segment will continue to contribute positively to overall economic activity and growth. Expansion of the guesthouses segment could be complemented to higher-value-added resorts, where the guesthouses segment may help broaden tourist base by catering to a group of different—likely lower-cost—tourists. This would help grow the size of tourism GDP and contribute positively to economic inclusion in the Maldives.

1/ Prepared by Adam Remo (ICD). 2/ The estimate was done on data starting from 2016Q1 as guesthouses represented only a small share before 2016. The periods from 2020Q1 to 2021Q4 were excluded from estimation due to COVID-19 pandemic disruption to the tourism sector.

China Structural Slowdown and the Maldivian Economy1

Since the early 2010s, China has become the leading source of tourists for the Maldives' tourism industry. China overtook Germany, Italy, and the UK in tourist arrivals to the Maldives in 2010 (text figure). The Chinese market share reached its highest level in 2014, when the Maldives welcomed 363.6 thousands visitors from China, accounting for more than 30 percent of the total arrivals. However, the COVID-19 pandemic and the border restrictions imposed by the Chinese authorities have severely affected the tourist arrivals from China. In 2021 and 2022, the Chinese market share in the Maldives’ tourism industry dropped sharply to only 0.2 and 0.9 percent, respectively.

A001fig12

Maldives: Tourist Arrivals By Source Markets

(In percent of total)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Authorities' Data and IMF Staff Caclculations.
A001fig13

Interlink between China and the Maldives

(In percent, 2000-2018 data)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF World Economic Outlook, October 2023 and IMF Staff Calculations.

The Maldives' real GDP growth is strongly correlated with China's demand for service imports, indicating that the Chinese market will remain a key driver of the Maldives' growth. Historical data from the two decades before the pandemic show a positive relationship between China’s service imports and the Maldives’ real GDP growth (text figure). After China reopened in early 2023, the Maldives saw a recovery in Chinese tourist arrivals and market share. In the third quarter of 2023, China accounted for 19 percent of the total arrivals to the Maldives. The resilience of the Chinese market suggests that China’s travel imports will continue to support the Maldivian economy.

A001fig14

China's Real Import Growth Projection

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF World Economic Outlook, October 2023.

China's trend slowdown could, nevertheless, pose downside risks to the Maldives' medium-term growth. According to the October 2023 IMF’s World Economic Outlook (WEO), the growth of China’s real service imports is expected to sharply slow from 13.5 percent in 2024 to around 4.6 percent annually until 2028.2 While service imports from China would remain relatively strong over the medium term, the spillover effects of China’s medium-term slowdown on the Maldives are likely to be very limited under the baseline scenario and further growth slowdown in China could create a headwind to the Maldivian economy.

1/ Prepared by Yizhi Xu (APD). 2/ Despite China's structural slowdown, the downward revision of China’s medium-term growth since the April 2023 WEO mostly affect the growth of its goods imports and its demand for service imports is expected to hold up.
Figure 1.
Figure 1.

Maldives: Key Economic Developments

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Maldives Bureau of Statistics, Ministry of Finance, Maldives Monetary Authority (MMA); and IMF staff calculations
Figure 2.
Figure 2.

Maldives: External Sector Developments

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Maldives Monetary Authority (MMA); Ministry of Finance; and IMF staff projections.
Figure 3.
Figure 3.

Maldives: Fiscal Sector Developments

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: Maldives Monetary Authority (MMA); and Ministry of Finance.
Figure 4.
Figure 4.

Maldives: Monetary and Credit Developments

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authority (MMA); and IMF staff calculations.
Figure 5.
Figure 5.

Maldives: Financial Sector Developments

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Maldives Monetary Authority (MMA); and IMF staff calculations.
Figure 6.
Figure 6.

Maldives: Macro-Structural and Climate Change Indicators

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: UN Population (2022); World Governance Indicators (2022); International Labour Organization; World Bank Gender Data Portal; UNESCO Institute for Statistics; INFORM Global Risk Index (2024); Notre Dame Global Adaptation Initiative (2021); and IMF staff calculations.
Table 1.

Maldives: Selected Economic and Financial Indicators, 2021-2029

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Sources: Maldivian authorities; World Ban k; and IMF staff projections. 1/ CPI-Male definition. 2/ Including possible new sou rces of domestic financing or negotiated official bilateral financing as higher external financing costs are limiting options to tap international capital markets.
Table 2.

Maldives: Balance of Payments, 2021-2029

(In millions of USD, unless otherwise indicated)

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Sources: Maldivian authorities; and IMF staff projections. 1/ There are no capital transfers. 2/ MMA liabilities include swaps with Reserve Bank of India (RBI) 3/ These flows include external borrowing of the private sector. 4/ Public and private external debt includes IMF, but excludes domestic foreign-currency denominated debt.
Table 3.

Maldives: Summary of Government Operations and Stock Positions, 2021-2029

(In millions of Rufiyaa)

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Sources: Maldivian authorities; and IMF staff projections. 1/ Transfers to the Sovereign Development Fund are recorded as negative domestic financing, and withdrawals as positive financing.
Table 4.

Maldives: Summary of Government Operations and Stock Positions, 2021-2029

(In percent of GDP, unless otherwise indicated)

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Sources: Maldivian authorities; and IMF staff projections. 1/ Transfers to the Sovereign Development Fund are recorded as negative domestic financing, and withdrawals as positive financing.
Table 5.

Maldives: Monetary Accounts, 2021-2029

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Sources: Maldivian authorities; and IMF staff projections. 1/ Gross international reserves is equivalent to gross foreign assets of MMA. 2/ Commercial Bank Balance Sheet FX Gap is the difference between total FX denominated assets and total FX denominated liabilities on commercial banks’ balance sheets.
Table 6.

Maldives: Financial Soundness Indicators—Local Banking Sector, 2018-2023Q3

(In percent, unless otherwise indicated)

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Sources: IMF Financial Soundness Indicators; and Maldives Monetary Authority. 1/ Data for 2023Q3 are from Maldives Monetary Authority.
Table 7.

Maldives: FSAP Recommendations

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1/ I: Immediately; ST: short term = 1 -2 years; MT: medium term = 3-5 years. 2/ MMA: Maldives Monetary Authority; MoED: Ministry of Economic Development and Trade; MoF: Ministry of Finance; MoJ: Ministry of Justice; MBS: Maldives Bureau of Statistics; DJA: Department of Judicial Administration; ELA: Emergency Liquidity Assistance; NFIS: National Financial Inclusion Strategies; MSME: Micro, Small, and Medium Enterprise.

Annex I. Implementation of IMF Policy Recommendations

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Annex II. External Sector Assessment1/

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Annex III. Risk Assessment Matrix 1

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Annex IV. Reforms of State-Owned Enterprises 1

State-owned enterprises (SOEs) pose significant challenges for the public finances in the Maldives, as they often require large and ad-hoc budget support to address their solvency and liquidity issues. Their elevated external debt guaranteed by the government constitutes contingent liability to the central government. The current legislation and oversight framework for SOEs are inadequate and fragmented, and the performance management of SOEs is not aligned with their objectives and long-term goals. Reforms to SOE framework and operations are critical to support the sustainability of public finances. Priorities include rationalizing the SOE portfolio, harmonizing SOE institutional and oversight framework, and adopting a structured performance management framework.

A. SOE Fiscal Risks in the Maldives

1. Continued support to SOEs have weighed on central government budget. There have been substantial budget transfers to SOEs by way of both capital injections and subsidy payments, and the Ministry of Finance supports a small number of SOEs with sovereign guarantees of their external borrowings. During 2022, equity injections and subsidies were budgeted to be MVR 2.4 billion and cover 22 of the 30 SOEs. In actuality, the total funding provided to SOEs in 2022 by way of subsidies and equity was substantially higher at MVR 5.2 billion. As the purchase prices for many subsidized goods have increased significantly over the last two years, the funded value of the subsidies has been significantly in excess of the budgeted amounts earmarked to fund the subsidies. These ad-hoc funding support also crowded out other priority spending. While SOEs themselves have poorly developed risk management frameworks, this has resulted in many corporate risks being unnecessarily borne by the central government.

2. The Government of Maldives also provides sovereign guarantees for some SOEs. Sovereign guarantee of SOE debt currently accounted for US$1.5 billion, or 1.4 percent of GDP. SOEs such as Housing Development Corporation (HDC) and Fahi Dhiriulhun Corporation (FDC), which deliver large-scale government-funded housing projects and take up around 70 percent of total guaranteed SOE debt, face challenges in servicing their debt, due to high rental arrears. Such SOE guaranteed debt is also attached with cross-default clauses2, which amplifies the magnitude of potential sovereign support.

3. Financial risks arising from liquidity strains has further deteriorated. Based on IMF's SOE Health Check Tool, 6 out of 9 SOEs have seen upgrades in the overall risk rating in recent years (Annex Table 1). The improvement mainly reflects better SOE profitability (e.g., cost recovery) and solvency conditions (e.g., debt to assets and debt to earnings before interest, tax, depreciation, and amortization (EBITDA)). However, non-financial SOEs in the Maldives remain vulnerable to significant and persistent liquidity risks. Particularly, all non-financial SOEs in the Maldives are facing "very high risk” of failing to collect bills from customers on time—as indicated by very high creditor turnover days—whereas 6 SOEs were considered as facing "very high risk” in 2020.

Table 1.

Maldives: SOE Fiscal Risk Assessment 1/

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Source: IMF Staff Estimates. 1/ Profitability ratios measure the capacity of the SOE to generate sufficient profit for its shareholders. Liquidity ratios measure the capacity of the SOE to meet its short-term obligations. Solvency ratios measure the capacity of the SOEs to meet its long-term obligations.

B. Institutional Arrangements

4. The underlying causes of the fiscal risks embedded in Maldives’ SOEs are many. They include the lack of clear and commercial objectives for SOEs, the absence of a proper framework for identifying, funding and costing non-commercial services, and the poor risk management practices of SOEs. Most SOEs do not have a formal risk management policy and leave the government to bear the consequences of external shocks, such as interest rate and oil price fluctuations.

5. Institutional arrangements for SOEs oversight are fragmented. These include:

  • The Privatization and Corporatization Board (PCB) is the main entity responsible for overseeing state-owned enterprises (SOEs) in the Maldives, under its own legislation. PCB monitors and evaluates SOEs through quarterly and annual financial reports, which are often delayed and incomplete. PCB also develops and applies various codes and policies to improve the governance of SOEs, such as a corporate governance code, procurement regulations, and a strategic action plan.

  • The State Shareholding Management Division (SSMD), newly established at the Ministry of Finance, which focuses on supporting the budget process for SOEs (in particular, in relation to subsidy payments and capital injections) and then managing the immediate cash needs of SOEs. This occurs on a fortnightly basis and has allowed very little time for SSMD to focus on more strategic management of fiscal risk.

The delineation of responsibilities between Privatization and Corporatization Board (PCB) and State Shareholder Management Division (SSMD) is not well defined. While PCB is responsible for monitoring and evaluation of SOEs, SSMD has been tasked with fiscal risk management. By separating performance management (which is the responsibility of PCB) from fiscal risk oversight (the responsibility of SSMD), the structured performance management framework is compromised and the capacity to effectively manage fiscal risks is diluted. It is therefore crucial for the authorities to take a more coordinated approach to structure the performance management framework.

6. The current administrative framework could be enhanced. With the help of IMF TA, the authorities are drafting a new SOE law to establish clear roles and responsibilities for the government and SOEs, and set out a consistent and effective approach to risk management, capital allocation, and governance. The law would also enable a review of the ownership model for SOEs, which could have a significant impact on reducing fiscal risks.

C. Conclusions and Policy Recommendations

7. Reforms of SOEs and their institutional arrangements are critical to lessen their reliance on central government and safeguard public finances. SOE fiscal risks remain acute, particularly because most SOEs require large and unpredictable budget support, and many SOEs are facing heightened liquidity risk. Meanwhile, the government guarantees some of the SOE debt, which is highly exposed to the heavy debt service obligations of these SOEs. Reform priorities should include:

  • Rationalizing SOEportfolios. A more precise definition of SOEs and the SOE ownership rationale should be adopted to pave the way for a rationalization of the current large portfolio of SOEs. For instance, some SOEs are too small or unprofitable to justify the costs of their operations and management, while others are non-commercial in nature and do not fit the performance criteria of SOEs. The government should consider different options for these SOEs, such as dissolution, reclassification, or sale. The adoption of a new SOE Law could provide a clear and consistent framework for defining and regulating the SOE portfolio.

  • Harmonizing SOE institutional and oversight framework. A new SOE law should include an ownership policy that defines the objectives and scope of SOEs, an institutional framework that clarifies the roles and responsibilities of the oversight bodies, and a performance management and oversight framework that sets and enforces SOE specific goals. Although creating an SOE holding company could help consolidate institutional framework, this would require a rationalization of the SOE portfolio as mentioned above.

  • Adopting a structured performance management framework. The PCB oversees the performance of SOEs through five-year agreements that link management and board remuneration to financial metrics. However, this approach has some drawbacks, such as neglecting the specific objectives and long-term goals of each SOE. A better framework would involve setting clear and enduring objectives for each SOE, and agreeing on a set of financial and non-financial performance targets that are tailored to each entity and industry. The performance agreement would also include a financial budget, a capital expenditure program, and a documentation of all non-commercial activities and their funding arrangements. The oversight body would monitor the compliance with the agreement and evaluate the performance of the board and management based on the criteria, objectives and targets. This would allow for more effective and accountable management of SOEs and their fiscal risks.

Annex V. Macro-Financial Linkages and Financial Sector Vulnerabilities 1/

Macro-financial linkages generated from sovereign-bank nexus, high dollarization, and shortages of foreign exchange (FX) pose a combination of vulnerabilities to the Maldives. The recent Financial Sector Assessment Program (FSAP) for the Maldives concluded that the financial system is resilient to moderate shocks but vulnerable to severe shocks related to economic downturn and currency devaluation. Reforms to strengthen the systemic liquidity management framework, the banking sector regulatory and supervisory framework, macroprudential policy instruments, and the stress testing and climate risk analysis are essential to contain systemic risks to financial stability.

A. Macro-Financial Linkages in the Maldives

1. Macro-financial stability in the Maldives is threatened by pockets of vulnerabilities. They stem from high public debt, sovereign-bank nexus, sectoral loan concentration, FX shortages, limited market mechanisms, under-reported shadow banking activities, and susceptibility to external shocks and climate change. While risks arising from public and non-financial corporate borrowers could migrate to banks' balance sheets through direct exposure, lack of market liquidity management mechanism to redistribute excess liquidity further deteriorates FX shortages that originate from a surge in import-related public investment and rising global commodity prices. In a broader financial system, shadow banking activities remain substantially underreported and climate risks are rising, while poor data disclosure could hinder proper measures to tackle these vulnerabilities.

2. The sovereign-bank nexus remains the main macro-financial vulnerability, as regulatory policies continue to contribute to banks’ sovereign debt holdings. Banking sector exposure to sovereign debt continues to rise above 30 percent of total banking sector assets, and sovereign exposure as share of total bank capital is higher than 400 percent in some banks. Compared with peer countries in the region, the banking system in the Maldives stands out with the highest sovereign exposure. In the current regulatory framework, the Maldives' government securities bear zero risk weight and provisioning is not required. The Maldives' government securities across all maturities are treated by banking supervisors as High-Quality Liquid Assets (HQLA) although liquidity coverage ratio (LCR) regulation has not been introduced in the Maldives, and sovereign debt holdings and government-guaranteed loans are exempt from single exposures limits. All these regulatory policies have induced banks' substantial sovereign debt holding. Meanwhile, heightened public and SOE debt could erode fiscal space and jeopardize SOEs' viability, which could risk spillovers to banks that are significantly exposed to sovereign risks.

A001fig21

Banking Sector Sovereign Debt Holding to Total Asset Ratio

(In percent)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Haver Analytics; and IMF staff calculations.

3. Banks face risks from large exposures to a few sectors and corporates, loan dollarization, and FX liquidity mismatches. Banks' loan portfolios are highly concentrated in tourism and construction, and many banks are highly exposed to a few large corporates. Some are close to the single exposure limit of 15 percent of regulatory capital. Under sufficient stress, banks may breach the single exposure limit even if remaining above the minimum capital adequacy ratio (CAR) requirement. Dollarization of loans to private nonfinancial corporates is particularly high at 75 percent, and a large bank has a negative net open FX position (NOP) outside the regulatory limit. Significant maturity mismatch between longer-term loans and ample daily callable deposits that also exhibit seasonality poses FX liquidity risk.

4. Market mechanisms for redistributing liquidity across banks are limited in Maldives. Excess liquidity in the system arose as the Maldives Monetary Authority (MMA) provided significant amount of financing to the central government. In absence of active open market operations or standing facilities, the main monetary instrument to manage systemic liquidity is the minimum reserve requirement (MRR). Lack of differentiation between MRR on local currency and FX deposits could increase dollarization in the economy.

5. Another vulnerability centers around “shadow banking” by non-banks. Finance companies providing lease and hire purchase options not always perform rigorous creditworthiness checks. Total recurrent household payment obligations remain unclear since most companies are not registered with the credit information bureau (CIB). As such schemes flourish unobserved by regulators, households could become overstretched and delinquencies rise.

6. Finally, the Maldives’ longstanding macroeconomic vulnerabilities are also exposed to various external risks to financial stability. External shocks commodity price volatility, higher bank funding costs, balance sheet deterioration, and security incidents could spill over to banking sector through loan portfolio deterioration. The Maldives is exceptionally vulnerable to climate change, especially sea level rise and coastal flooding, which could affect the economy and the financial system.

B. Banking Sector Vulnerabilities

7. Banks dominate the financial sector (Annex Table 1). As of end-2022, total asset size of Maldives' banking sector reached MVR 88,552 million, accounting for more than three-fourths of financial system assets (two private domestic banks, five foreign-controlled banks and one domestic state-owned bank, with two of the foreign banks also state-owned). Three-fourths of banking system assets are controlled by either the Maldives or foreign governments. The sector is very concentrated (Herfindahl-Hirschman Index near 3,000, well above peers, Annex Figure 1), with the largest bank holding 51 percent of system assets.

Table 1.

Maldives: Structure of the Financial System

(Data as of end-2022)

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Sources: MMA Monthly Statistics, Maldives Pension Administration Office (MPAO); IMF Staff calculations. Note: Financial service providers outside the regulatory perimeter are not included.
Figure 1.
Figure 1.

Maldives: Banking Sector

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Sources: Data for Maldives are from the Maldives Financial Review, data for the rest of the countries from their respective central bank or Fitch Connect.Note: Data for Seychelles and Nepal as of 2020, and for Mauritius as of 2022 Q2.

8. The joint IMF-World Bank’s Financial Sector Assessment Program (FSAP) stress tests cover a range of analysis to gauge the banking sector resilience to economic shocks. These span from stress tests to bank solvency and credit concentration, liquidity, sovereign risks, market risk, and climate change shocks. The stress tests were performed from both top-down at the aggregate banking sector level and bottom-up at bank-by-bank balance sheet analysis. The solvency stress test is predicated on three scenarios. The baseline and moderate stress scenarios reflect the IMF’s projections2. The third is a bespoke crisis scenario assuming a deep, if short-lived, recession from external distress that combined with mounting domestic imbalances causes a devaluation (by 20 percent) and a domestic debt exchange of T-bills for bonds (25 percent face value reduction). The credit risk modeling found only inflation and import growth (proxy for economic activity)3 to be robust drivers. In addition, the sovereign stress in the severe scenario is based on a hypothetical situation of domestic debt exchange. It assumes a large exogenous shock that leads to a period of severe sovereign stress. Debt sustainability concerns limit external commercial and official sector support, resulting in a restructuring of domestic debt where T-bills and any other outstanding domestic government bonds (excluding those held by the MMA) are converted into a new bond on financial terms comparable to that given to the MMA in the most recent securitization of MMA claims (20-year maturity at an interest rate of 2.5 percent, equating to a 24.9 percent net present value loss applied as a haircut to the face value).

9. The stress test results corroborate that banks are less vulnerable to economic shocks than to an unraveling of the sovereign-bank nexus (Annex Table 2). The system's CAR remains largely unchanged in the moderate scenario. However, the impact of the assumed domestic debt exchange in the severe scenario4 causes the CAR to drop by 14.8 percentage points, with 3 banks (12 percent of assets) becoming undercapitalized. In addition, several banks combining for 30 percent of assets would breach the applicable single exposure limit due to falling capital. This finding, together with strongly falling CAR in the credit concentration test assuming default of the largest five borrowers, suggests the need for more frequent syndication of large commercial loans. Lastly, if imposing a 100 percent risk weight on domestic FX securities (as the BCP assessment recommends5), the CAR would drop by 9 percentage points when added to the severe scenario, with one bank exhausting most of its excess capital.

10. Nevertheless, the bottom-up tests by banks see a more moderate impact. In the severe scenario, despite significant decline in CAR among some reporting banks, all of them would maintain sufficient capital. The NPL ratio projections are largely consistent with the FSAP team's estimates, especially in the severe scenario. Banks also project high profitability under the baseline and a worsening performance under stress. In fact, the more benign results based on bottom-up tests could be due to cross-bank discrepancies (some banks did not submit the required metrics or used different starting-point capital than official data).

11. Liquidity stress tests6 indicate significant risk at individual institutions and a high susceptibility to withdrawals of large deposits. While all but one bank would meet the liquidity coverage ratio (LCR) requirements in both local and foreign currency, one bank each combining for 25 percent of system assets would fail a cashflow-based maturity mismatch test7 in local and foreign currency. Even more concerning is that about half of the banking system (measured by size) could not withstand the withdrawal of the five largest deposits, indicating inordinate deposit concentration.

12. Market risk from an interest rate shock is found to be manageable for most banks, while some are relatively exposed to FX risks in their balance sheets. The interest rate risk test simulates a symmetric increase of 200 basis points on the interest rates of assets and liabilities with residual maturities up to one year. The capitalization ratio drops by only 1.3 percentage point under this scenario, due to the short-term nature of loans and securities, of which two-thirds mature within one year (compared to 8 percent for liabilities). 8 The FX risk in balance sheets causes moderate changes in net open positions (NOPs) under a 20 percent devaluation assumption, but two banks exceed the relatively high upper NOP limit and a large bank's NOP becomes more negative and nears the single currency limit.

13. Climate stress test indicates that risks to financial stability from natural disasters may materialize over the long run. The climate risk analysis estimated a shock to physical capital under different climate scenarios9, leveraging authorities' and global data, and imposes it onto the financial system. The physical risk analysis suggests no material mid-century coastal flood impact on the banking system, but great uncertainty about more extreme conditions at the end of the century remains. The direct damages to the capital stock for mid-century may reach up to 3.4 percent, and 20 percent for the end-century. Despite the slow arrival of climate-related impact on financial stability, these results need to be interpreted with caution, given the high uncertainty surrounding the climate data, limited data to model the geographical exposures, as well as the possible indirect damages and spillover effects in Maldives' tourism-dependent economy.

C. Conclusions and Policy Recommendations

14. Banking sector stress tests suggest that Maldives’ financial system remains vulnerable to severe shocks related to sovereign, liquidity, market, and climate risks. The solvency stress test shows that the sovereign-bank nexus has exposed banks to sovereign risks. The liquidity stress test reveals significant risk at individual banks and a high dependence on large deposits. The market risk test indicates manageable interest rate risk but some exposure to FX risk for some banks. The climate risk test suggests no major impact from coastal floods until the end of the century, but with great uncertainty and possible indirect effects.

15. Systemic liquidity management framework and FX regulations should be established to mitigate risks posed by excess liquidity. MMA should swiftly differentiate reserve requirements by currency (higher rate on FX deposits) and within FX reserves by maturity (lower MRR on longer-term deposits) to mitigate dollarization risks. In the near-term, MMA should resume liquidity management operations, and introduce secondary local bonds market, including active primary dealers and an electronic platform for government debt securities auctions and trading. In addition, regulations on money changing businesses in the foreign exchange markets should be adopted. Reforms in the FX markets could mitigate FX shortage and prevent further pressures on the exchange rates due to excessive structural liquidity in the banking system.

16. The banking sector regulatory and supervisory framework needs further improvement to contain excessive risk-taking. The authorities should amend capital regulation to apply a 100 percent risk weight on bank holdings of Maldives government securities in foreign currency in a gradual pace and introduce liquidity requirements. Besides, MMA, as both financial regulator and supervisor, should issue regulatory standards to clarify the enforcement regime, reevaluate off-site monitoring procedures, and strengthen the independence of MMA’s Board of Directors.

17. Macroprudential policy framework and instruments should be deployed to tackle pockets of vulnerabilities. MMA should augment reporting of data on recurrent household payment obligations from leasing contracts to the CIB. MMA should also consult with stakeholders and establish a macroprudential framework, including a committee for macroprudential coordination, and publish a financial stability report. As credit flow is rebounding, it is also important to introduce key borrower-based and capital-related macroprudential policy instruments.

18. Finally, banking sector stress testing analysis and climate risk analysis should be further enhanced to closely monitor systemic risks. The supervisors should improve integrity and granularity of supervisory data, including data compiled by the Credit Information Bureau (CIB) that could help better track and safeguard household leverage. MMA is recommended to develop methodologies for solvency, liquidity, and market risk stress tests and engage banks in a dialogue about stress test procedures and results, including banks' own stress tests. Furthermore, there is an urgent need to improve granularity and coverage of climate and geographical exposures data for establishing climate risk analysis.

Table 2.

Maldives: Banking Sector Stress Test Results

article image
Source: Authorities' data and IMF Staff Estimates. 1/ According to MMA's Prudential Regulation on Foreign Currency Exposure Limits, the foreign currency open position exposure for all currencies shall not exceed 40 percent of a bank's capital base, and the single currency open position exposure shall not exceed 25 percent of a bank's capital base for a long position, and 15 percent for a short position.

Annex VI. Strengthening Integration of Climate Considerations into Public Financial and Investment Management1/

The Maldives is highly exposed to the climate change vulnerabilities and natural disasters. The integration of climate sensitivity into public financial management (PFM) and public investment management (PIM) processes can be a key contributor to government's strategies to combat the climate change. Key actions include: (i) introducing climate budget tagging (CBT) and a climate budget statement (CBS) into the budget process alongside more in-depth periodic long-term assessment of the fiscal costs and risks of climate change; (ii) providing new guidance to the public sector on how to incorporate climate sensitivity into investment plans; and (iii) adding climate dimensions to new policies on appraisal and selection projects and to those dealing with asset management and maintenance.

A. Context

1. The Maldives is highly exposed to climate change. The average elevation of the Maldives'

land area is under 1.5 meters above sea level, and more than 40 percent of the population live within 100 meters of the shoreline. Climate change poses a potentially existential threat to the low-lying islands of the Maldives through sea level rise and flood. The country is also vulnerable to ocean warming and resulting coral bleaching events, potentially affecting tourism activity over the longer term. The fiscal and climate vulnerabilities together pose significant risks to the economy, livelihoods, and food security, where the atolls outside of Male are particularly vulnerable.

2. The Maldivian authorities are taking steps to enhance climate policies to meet its renewed climate mitigation objectives and adaptation needs. Various national mitigation and adaptation strategic plans and policies are enacted. Importantly, the Nationally Determined Contribution (NDC) of Maldives updated in 2020 lays out plans to reduce CO2 emissions by 26 percent by 2030 and strive to achieve net zero emissions by 2030 if there is adequate international support and assistance. In addition, the Climate Emergency Act of 2021 that sets out the conditional plans to achieve net-zero emission and large adaptation needs mainly in renewable energy and resilient infrastructure. The Maldives' Integrated Financing Framework (INFF) in 2023 also provides broad principles and options for pursuing climate financing. The climate adaptation and mitigation costs are estimated at US$8.8 billion (159 percent of 2022 GDP) and US$1 billion (18 percent of 2022 GDP) respectively. The cost of adaptation is based on some sectoral assessments mainly covering the cost of coastal protection in all inhabited islands. The Government of the Maldives is developing the National Development Strategy that lays out the country's 20-year development vision, which will include a new National Adaptation Plan (NAP) and associated implementation strategies.

B. Integration of Climate Considerations into PFM and PIM

3. The integration of climate sensitivity into public financial and investment management processes can be a key contributor to government’s strategies to combat climate change. Green Public Financial Management (Green PFM) helps with the design and implementation of fiscal and expenditure policies that are responsive to climate. It allows for the integration of climate change considerations into fiscal strategy, budget preparation, budget implementation, and control and audit processes. The Green PFM assessment is complemented by the climate-sensitive Public Investment Management (Climate PIMA) framework - with a focus on ensuring that climate change considerations are mainstreamed into the public investment decisionmaking processes, including project appraisal, selection, and management.

Figure 1.
Figure 1.

Maldives: Linking Green PFM and C-PIMA

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF Staff.

4. Delivering on Green PFM and climate-related PIM reforms could be part of the ongoing broader PFM and PIM reforms. A new PFM reform strategy is being prepared to continue improving the fundamental elements of the budgeting process accompanied by legal reforms. Ongoing PFM initiatives supported by development partners could serve as enablers for developing green PFM tools. With the limited fiscal space, spending efficiently and making carefully prioritized spending decisions to respond to the climate challenge is more critical than ever. Where access to climate financing is demanding on PFM related requirements, the authorities are encouraged to continue their PFM reforms to improve current PFM practices and make them environment and climate sensitive. IMF's Public Investment Management Assessment (PIMA) highlighted underlying weaknesses in public investment and financial management, including critical areas such as investment planning, project appraisal and selection, project funding, and the development of a realistic project pipeline. Without progress on these fundamentals the integration of more advanced climate change considerations into PFM procedures is unlikely to be successful. The C-PIMA assessment needs to be built on these ongoing efforts for improving the underlying PFM system.

5. Key actions to incorporate climate considerations into PFM and PIM could be summarized as the following:

  • Introducing climate budget tagging (CBT) and a Climate Budget Statement (CBS) into the budget process alongside more in-depth periodic assessment of the fiscal costs and risks of climate change. The authorities could design CBT methodology and introduce this methodology in the preparation of the 2026 budget, including for the assessment of new policy initiatives, and use CBT to monitor climate-related expenditures in execution. Work is ongoing in this respect with UNDP (United Nations Development Program) support, building up on experience with Sustainable Development Goals (SDG) budgeting. Meanwhile, the authorities could prepare and publish a first CBS as part of the budget proposal, including elements from CBT applied in budget preparation. In the longer term, the authorities should undertake an indepth periodic assessment of the long-term fiscal costs and risks of climate change by committing to regular periodic analysis of the long-term fiscal costs, risks, and impacts of climate change, and potentially other policy areas that will affect long-term fiscal sustainability.

  • Providing new guidance to the public sector on how to incorporate climate sensitivity into investment plans, with a stronger role for the Ministry of Finance (MoF) and Ministry of Climate Change, Environment and Energy (MoCCEE) in enforcing this. The authorities should issue joint MOF/MoCCEE regulation providing guidance on developing costed climate-sensitive sector and local public investment plans and SOE business plans; and require MoF and MoCCEE to review and verify that these plans contribute to NDC targets and are financially realistic.

  • Adding climate dimensions to new policies on project appraisal and selection processes and to improved systems dealing with asset management and maintenance. The authorities should develop PIM regulations clarifying the project appraisal and selection processes and include climate-related analysis and criteria in these processes. Meanwhile, climate dimensions need to be incorporated into improved systems for dealing with asset management and maintenance by preparing guidelines for fixed assets registration that include climate related information and a methodology for calculating the costs of maintenance of fixed assets that includes climate considerations.

Annex VII. Capacity Development Strategy 1/

The Maldives is one of the intensive IMF capacity development (CD) recipients amongst countries in Asia and the Pacific region. CD priorities are closely aligned with IMF surveillance policy recommendations that include revenue mobilization, expenditure rationalization, public financial and debt management, financial sector reforms, and monetary and exchange rate policies.

1. CD continues to support the authorities’ reform efforts to address economic vulnerabilities in the Maldives. Reflecting IMF Surveillance policy priorities to swiftly implement a comprehensive set of reforms to reduce fiscal, debt, and external vulnerabilities, and strengthen economic resilience, CD support for the Maldives has been intense, particularly to strengthening its institutions and policy frameworks in the area of tax policy and administration, expenditure policy, and public financial management (Annex Text Figure 1, left chart). CD provided to the Maldives has been effective, where more than half of CD activities achieved their milestones (Annex Text Figure 1, right chart). CD is currently delivered by both regional advisors from IMF South Asia Regional Training and Technical Assistance Center (SARTTAC) and headquarter-based missions.

A001fig25

IMF Techanical Assistance Provided to Asia-Pacific

(In thousands of US dollars, IMF fiscal year May 2022-April 2023)

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Source: IMF CDMAP.
Figure 1.
Figure 1.

Maldives: CD Workstream and Achievements in FY23

Citation: IMF Staff Country Reports 2024, 106; 10.5089/9798400275920.002.A001

Fiscal Policy

2. Background. CD in fiscal policy area highlights the Maldives' urgent need to implement a sustained fiscal consolidation comprising revenue mobilization effort and expenditure rationalization to reduce public debt vulnerabilities. Fiscal reforms to improve public spending efficiency, enhance fiscal transparency, and manage fiscal risks are also crucial.

3. Ongoing and planned activities on tax policy and administration. Ongoing activities include a review of the amendments to income tax act on tax policy and strengthening custom administrations with the Maldives Customs Service (MCS) (e.g., Integrated IT system). Going forward, on income tax policy, planned activities include a review of productivity and scope for improvement (e.g., simplification measures such as a presumptive tax for SMEs), tax thresholds, and antiavoidance provisions for large multinational businesses). On excise, CD priorities would include the introduction of a new Excise Act that is currently deliberated as part of the ongoing Medium-Term Revenue Strategy (MTRS). On tax expenditures, a follow-up on reporting and evaluation would be considered. On tax administration, CD support to the Maldives Inland Revenue Authority (MIRA) and MCS is expected to continue to support the MTRS in priority areas, such as international tax, development of an IT Strategy, high-wealth individual compliance, taxation in the financial sector, and post clearance audit. Coordination with other development partners will continue.

4. Ongoing and planned activities on expenditure policy and public financial management. Strengthening public financial management and public investment management remains priorities. Ongoing activities include a review of pension system reform to assess its fiscal sustainability, a review of fiscal risk management in SOEs, and integration of climate change into the public financial and investment management (Green PFM and Climate PIMA). The authorities are implementing the recommendations of the past CD support including on the Fiscal Responsibility Act (FRA), the Public Debt Management Law, and drafting of the Sovereign Development Fund (SDF) law in 2023, energy subsidy reforms in 2022, and on fiscal transparency evaluation (FTE) in 2021. CD on developing macro-fiscal forecasting and medium-term macroeconomic framework tools, currently being provided by ICD, will also help build the authorities' capacity to strengthen fiscal policy making. Planning activities include "drafting a Sovereign Development Fund Law” and "drafting a new SOE Law.”

Monetary and Exchange Rate Framework

5. Background. For monetary and exchange rate policies, CD will continue to focus on operationalizing an interest rate-based framework (i.e., interest rate corridor). The Maldives Monetary Authority (MMA) strategy to build reserves is also aiming at normalizing FX operations, redirecting FX receipts from the parallel market, and reviewing FX allocation to SOEs. This would help enhance macroeconomic stability and bolster external buffer against external shocks.

6. Ongoing and planned activities. IMF TA has covered MMA strategic plan, central bank governance, function two-way FX market, and active liquidity management. Looking ahead, IMF TA will continue to assist the implementation of the MMA's Strategic Plan through a multi-year TA program, aiming to: (i) strengthen the monetary policy and operational framework, including defining an interest rate corridor and directing interbank interest rates inside it, through reactivating open market operations (OMOs), (ii) develop functioning FX markets, and (iii) review the current exchange rate regime to support resilience and implement a strategy for partial and gradual de-dollarization and FX reserve accumulation.

Financial Sector

7. Background. Since January 2018, SARTTAC has provided CD support to strengthening the financial sector supervisory capacity of the MMA in three areas, including banking and insurance supervision and non-bank financial institutions (NBFIs) regulation. A joint IMF-World Bank Financial Sector Assessment Program (FSAP) with the Maldives concluded May 2023 identified the key financial sector vulnerabilities arising from bank-sovereign nexus, high dollarization, and FX scarcity. FSAP recommendations centered on strengthening bank regulations and supervisions to address such macro-financial systemic vulnerabilities.

8. Ongoing and planned activities. IMF CD focused on developing and implementing riskbased banking supervision (e.g., the preparation of the implementation of risk management guidelines, reviews of on-site inspection and off-site supervision manuals, and drafting of a regulation on liquidity risk management), as well as improving and disseminating financial soundness indicator (FSI). Going forward, while CD will continue to assist the authorities in the area of risk-based supervision, CD activities will be aligned with FSAP recommendations and priorities.

Table 1.

Maldives: Integrating Fund Surveillance and Capacity Development (CD)

article image
Source: IMF Staff. Note: CD providers by IMF departments include Fiscal Affairs Department (FAD), Institute of Capacity Development (ICD), Legal (LEG) Department, Monetary and Capital Markets (MCM) Department, Statistics (STA) Department, and South Asia Regional Training and Technical Assistance Center (SARTTAC).
1

Losses in education opportunities remain significant, with secondary school enrollment rates still lower than prepandemic levels (https://www.moe.gov.mv/assets/upload/STAT BOOK 2021 2022 V2.1 ready.pdf).

2

Based on World Bank’s Maldives Economic Update (October, 2023), data are measured at the US$6.85 poverty line in 2017 purchasing power parity.

3

GST rate hikes are expected to yield GST revenue collections of 12.9 percent of GDP in 2023, compared with a counterfactual analysis without GST reforms that would yield GST revenue collections of 9.7 percent of GDP.

4

The authorities are expediting the VIA terminal expansion to be completed in the last quarter of 2024, which could potentially provide an upside risk to growth.

5

In the baseline forecast, the subsidy reform measures on energy, electricity, and other items and Aasandha reforms will be implemented since July 2024, as currently envisaged in the 2024 budget. However, expensive medical services will remain covered by Aasandha and rationalization on capital expenditure is limited.

6

Based on the World Bank's Maldives Public Expenditure Review (2022), spending on Aasandha health insurance scheme grew at 18 percent annually, on average between 2014 and 2019. In absence of robust procurement and purchasing system, the average drug prices under Aasandha scheme were 15 to 75 times higher than international benchmarks.

7

The PIT exemption threshold is current set at more than three times GDP per capita and the maximum of PIT rates is at 15 percent.

8

Under the existing rules specified in the FRA, MMA may provide advances for liquidity management purposes only which shall not exceed 1 percent of average of the government revenues in the last three years.

9

Based on staff's analysis, increasing MRR when commercial banks' excess liquidity is high would likely not lead to significant changes in commercial banks' interest rates. The private sector lending and deposit rates were stable in the past and have not changed significantly even after changes in MRR. This holds for MRR and commercial banks rates in both MVR and USD.

10

The exchange restriction previously found has been modified due to the prioritization of FX.

11

The climate adaptation and mitigation costs are estimated at US$8.8 billion (159 percent of 2022 GDP) and US$1 billion (18 percent of 2022 GDP) respectively. The cost of adaptation is based on some sectoral assessments mainly covering the cost of coastal protection in all inhabited islands. Both adaptation and mitigation costs are provided by the Ministry of Environment, Climate Change, and Technology. Some specific and limited revenue measures are in place to fund the climate mitigation and adaptation strategies such as the Maldives Green Tax and the Baa Atoll Conservation Fund. The 2022 budget approved a potential issuance of green/blue bonds. The Maldives has developed a pipeline of projects totaling US$500 million for the Green Climate Fund (GFC), which are part of the Public Sector Investment Program.

1

Prepared by Yasuhisa Ojima (APD).

1/

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, "medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. Structural risks are those that are likely to remain salient over a longer horizon.

1

Prepared by Yizhi Xu (APD) based on IMF's SARTTAC technical assistance provided to the Maldives and its report of "Review of Fiscal Risk Management in State Owned Enterprises" (August 2023).

2

The cross-default clause added to HDC and FDC bonds stipulates that a default event with one bond would trigger defaults on all other bonds issued by the same borrower.

1

Prepared by Yizhi Xu (APD).

2

Baseline and downside scenarios in the 2022 IMF Article IV staff report of the Maldives.

3

Exports could not be used because they do not include tourism, and real GDP growth is available only annually.

4

The test simulates a domestic debt exchange of T-bills into longer-dated and lower-yielding bonds. Consistent with Fund guidance (IMF WP/19/266) and standard practice in FSAPs with sovereign nexus analyses (e.g., Bahamas (2019), South Africa (2022), WAEMU (2022)), all T-bills were stressed, irrespective of regulatory treatment.

5

BCP assessment conducted during the recent FSAP mission recommended amending capital adequacy rules to increase risk-weight on domestic sovereign exposure in FX from 0 to 100 percent, which is in line with the Basel III framework that requires such risk-weight for the Maldives' B- rating (Fitch).

6

The Net Stable Funding Ratio was not computed due to lack of information on stable vs. non-stable funding.

7

Based on assumptions for run-off rates on funding sources and roll-off rates on assets to estimate the funding gap based on historical volatility.

8

The average maturity of T-bills is 290 days. Banks deliberately space their bond purchases such that equal parts come due each month. The short maturity would, however, lengthen a lot in case of a domestic debt exchange.

9

For the hazard component, the assessment considered global climate data on sea level rise and storm surge height on actual conditions and future climate scenarios, SSP2-4.5, SSP3-7.0, and SSP5-8.5.

1

Prepared by Yasuhisa Ojima (APD), based on IMF's FAD technical assistance provided to the Maldives and its draft report of "Mainstreaming Climate Change into Public Financial and Investment Management Green PFM and Climate PIMA" (January 2024).

1

Prepared by Yasuhisa Ojima (APD).

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Cover IMF Staff Country Reports
Maldives: 2024 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Maldives
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2024: Issue 106
Publisher:
International Monetary Fund
ISBN:
9798400275920
ISSN:
1934-7685
Pages:
101
DOI:
https://doi.org/10.5089/9798400275920.002

Maldives: Economic Performance

(In percent, average over relevant period)
Text Figure 1.

Maldives: Tourist Arrivals and Economic Activity

Maldives: Central Bank Fiscal Financing

(In billions of MVR) 16

Maldives: Public Investment and Future Real GDP Growth 1/

(In percent)

Maldives: Net Foreign Exchange Assets and Excess Liquidity 1/

(In millions of MVR)

Banking Sector Sovereign Debt Holding to Total Asset Ratio

(In percent)
Text Figure 2.

Maldives: Macro-Financial Linkages of the Sovereign-Bank Nexus

Maldives: Exposure to Climate Change Index

Range 0-1, higher score means more vulnerable to climate change)

Maldives: Tourist Accomodation by Type

(Bednights, in Millions)

Maldives: Tourism Sector Growth in Maldives

(In percent, year-on-year)

Maldives: Tourism Sector GDP Growth 1/

(In percent, year-on-year)

Maldives: Tourist Arrivals By Source Markets

(In percent of total)

Interlink between China and the Maldives

(In percent, 2000-2018 data)

China's Real Import Growth Projection
Figure 1.

Maldives: Key Economic Developments
Figure 2.

Maldives: External Sector Developments
Figure 3.

Maldives: Fiscal Sector Developments
Figure 4.

Maldives: Monetary and Credit Developments
Figure 5.

Maldives: Financial Sector Developments
Figure 6.

Maldives: Macro-Structural and Climate Change Indicators

Banking Sector Sovereign Debt Holding to Total Asset Ratio

(In percent)
Figure 1.

Maldives: Banking Sector
Figure 1.

Maldives: Linking Green PFM and C-PIMA

IMF Techanical Assistance Provided to Asia-Pacific

(In thousands of US dollars, IMF fiscal year May 2022-April 2023)
Figure 1.

Maldives: CD Workstream and Achievements in FY23