IMF mission holds Article IV Consultation with Federated States of Micronesia
This statement summarizes the mission’s preliminary views and policy recommendations based on discussions in Pohnpei1. The discussions focused on policies to ensure long-term sustainability through strengthening fiscal management and promoting the private sector. The economy is expected to continue to expand at a moderate pace, supported mainly by new construction activities and a growing fisheries sector, but faces headwinds over the medium-term from the gradual decline of Compact grants and the lack of a vibrant private sector. In that context, a comprehensive package of a mediumterm fiscal consolidation plan with tax reforms and targeted expenditure cuts, as well as structural reforms to nourish private sector growth, is essential to secure fiscal and economic sustainability.
Since the last IMF Article IV consultation in 2010, the economy continued on a steady growth path. Following a recession in FY2006-08 due to delays in Compact grants utilization as well as high fuel and food prices, the FSM economy grew by 2-2½ percent for FY2010 and FY2011. The expansion was driven by new construction activities, such as the airport renewal projects funded by the US Federal Aviation Authority (FAA), and by growth of the fishery sector helped by good fishing conditions and high prices. The economy remains dependent on the large public sector (40 percent of GDP, including public enterprises), although there are signs of a further growth pick up in the fisheries and agriculture sectors.
Inflation moderated from its FY2009 peak, and fluctuations are largely driven by commodity prices. After reaching 7.8 percent in FY2009, inflation has declined to 4.6 percent in FY2011. However, the last quarter of 2011 recorded a 6.5 percent increase (yearon-year) reflecting the rise in international food and fuel prices, which compose about 46 percent of the consumption basket.
3. The overall fiscal balance of the consolidated government recorded modest surpluses for three straight years through FY2011, with an uneven distribution of out- comes across states. In FY2011, the overall consolidated fiscal balance was $1.9 million (0.6 percent of GDP) in surplus, helped by economic growth and fishing fee revenue. However, the surplus of the national government masks an aggregate deficit at the state government level3. While Chuuk and Yap turned in a surplus in FY2011 with better revenue administration, Kosrae and Pohnpei each recorded deficits equivalent to about 1 percent of state GDP.
Despite some deterioration of the current account balance (from -12 percent of GDP for FY2006-8 to -18 percent for FY2009-11 on average), external balance is sustained by a stable flow of official transfers. The majority of the overall current account deficit (19 percent of GDP in FY2011) is financed through capital transfers from official sources (13 percent of GDP). Given their contractual nature, they can be considered a stable source of funding. Similarly, imbalances within the current account balance (a trade and services deficit of 58 percent of GDP) are largely offset by a stable surplus in the income and transfer balances from Compact current grants and remittances (40 percent of GDP). Given the dedicated official funding sources, the level of gross international reserves (about 3½ months of imports) is not as much a critical indicator for the external sustainability as in other countries. The current account deficit widened in FY2011, with an increase in exports (mainly fish) more than offset by that in imports driven by construction materials and fuels. Visitor arrivals declined significantly in FY2011 to 20 percent below the FY2009 peak, while higher inflation than in trading partners has kept the real effective exchange rate at an appreciated level.
Financial conditions have remained tight. There are large spreads between deposit rates (around 1 percent) and loan rates (about 14 percent for consumer loans, about 7 percent for commercial loans), partly reflecting high risks involved in lending in the FSM, given limited availability of land as collateral. Commercial loan growth has been stagnant in recent years, while consumer loans saw some pick up.