On May 11, the Executive Board of the International Monetary Fund (IMF) concluded the 2015 Article IV consultation1 with the Federated States of Micronesia (FSM).
Micronesia’s economy is stagnating, as externally-funded infrastructure projects are moving slowly while difficulties in the business climate, in particular those related to land tenure issues, continue to hold back private sector development. Staff estimates real GDP growth of around 0.1 percent for the fiscal year 2014 (ending September), while inflation has dropped to 0.7 percent on the back of falling oil prices. The current account strengthened in to 2½ percent of GDP in 2014, due mostly to a one-off increase in tax revenues and an increase in fishing license fees. Growth in 2015 is projected to remain subdued at 0.3 percent, while consumer prices are projected to further decline to -1.0 percent thanks to the continued pass through of low oil prices.
The Micronesian economy is projected to grow at 0.6 percent in the medium term, while risks on the outlook are tilted to the downside. The expiration in 2023 of grants provided under the Compact of Free Association with the United States is a significant challenge for Micronesia, requiring the country to implement wide-ranging reforms to enhance fiscal sustainability and private sector growth. Damages caused by the recent Typhoon Maysak have revealed again Micronesia’s vulnerability to tropical cyclones, while disaster assistance arrangements with the United States help the nation to recover from those damages.
Some reforms have been started recently, in particular, fiscal consolidation efforts by the state governments under the Long-Term Fiscal Frameworks (LTFF) and the establishment of the Unified Revenue Authority (URA). A new legislation on credit unions is being prepared to extend the supervisory authority of the Banking Board. The recently produced “2023 Action Plan” shows further policy actions that are required, including the implementation of the tax reform package and regulatory reforms. Most of these policy actions will require legislative measures – hence the critical importance in achieving a wide consensus in a nation with a loosely federated structure.
Executive Board Assessment2
Executive Directors noted that medium-term growth prospects in the Federated States of Micronesia (FSM) remain weak given sluggish private sector activity, while fiscal challenges loom ahead, in particular, with the expiration of Compact grants in 2023. They also expressed concern about the impact of the damage caused by Typhoon Maysak in April, notwithstanding the provision of emergency assistance by the international community. Directors stressed the importance of critical fiscal and structural reforms to help lift the economy’s growth prospects and achieve fiscal sustainability beyond the expiration of the Compact grants.
Directors called for the formulation of a realistic long-term fiscal framework based on a wide consensus across the national and four state governments, with a view to achieving budgetary self-reliance in the post-2023 period. While commending recent progress—including the establishment of the Unified Revenue Authority, the transfer of the 2014 fiscal surplus to the FSM trust fund, and the start of the Long-Term Fiscal Framework by the state governments—Directors encouraged the authorities to redouble their efforts in strengthening fiscal consolidation. They advised swift implementation of the long-debated tax reform package, in order to raise the revenue-to-GDP ratio closer to regional averages. Directors also noted the scope for improved prioritization of public spending, including through wage moderation and expedited implementation of an updated infrastructure development plan.
Directors emphasized that improving the investment climate is key to achieving private-sector-led growth in the FSM. They encouraged the authorities to undertake growth-enhancing policy actions, particularly by addressing land tenure issues through land surveys and registration. Efforts to strengthen investor protection and contract enforcement, and expedited investment application approvals would also help to attract foreign direct investment. In this regard, attention should be paid to safeguarding FSM’s cultural heritage and pristine environment. Directors also supported greater bank credit expansion, including to SMEs, in order to help boost economic activity and promote diversified growth. They noted that business skills of SMEs should be strengthened to support formulation of more bankable business projects.
Directors agreed that expanding regulatory oversight of credit unions would help to preserve financial stability. They supported the authorities’ efforts to prepare a new Credit Union Act that places credit unions under the supervision of the Banking Board, with technical assistance from the Pacific Financial Technical Assistance Centre(PFTAC).
Directors encouraged the authorities to redouble efforts to strengthen the capacity to produce timely economic statistics, with technical assistance from the Fund and other donors.
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1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
2 At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.
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