Washington, DC:
An International Monetary Fund (IMF) team led by Piyaporn Sodsriwiboon held
virtual Article IV consultation with the FSM authorities and private sector
representatives during July 19-30, 2021. At the end of the mission, Ms.
Sodsriwiboon issued the following statement:
“The Federated States of Micronesia (FSM) has been successful in preventing
the spread of COVID-19 thus far. Public health measures have been
effective, and the economic policy response has been strong and broadly
appropriate, helping mitigate the negative impact of the pandemic on the
economy.
“Notwithstanding all these efforts, the near-term growth outlook has
significantly deteriorated. The economic contraction is likely to deepen in
FY2021 with growth falling to -3.2 percent in FY2021. A slow recovery is
projected for FY2022 driven by a gradual border reopening. Once the
pandemic fades, real GDP is expected to return to the pre-COVID level in
FY2023, albeit output will remain on a lower trajectory through the medium
term reflecting some permanent scarring. Inflation is expected to rise in
FY2021 due to higher imported prices including for commodities. Fiscal and
external balances are projected to remain in surplus in FY2021.
“Uncertainty surrounding the outlook remains high, and risks are tilted to
the downside. A longer border closure due to the pandemic or a possible
domestic outbreak could prolong subpar economic growth and put stress on
the fragile domestic health system. Uncertainty related to the expiration
of financial and services support under the Compact Agreement with the
United States could undermine investor confidence and weigh significantly
on the medium-term economic prospects, particularly the FSM’s capacity to
cope with a possible fiscal cliff post-FY2023. Given the country’s
geographic dispersion and isolation, climate change-induced natural
disasters remain a key downside risk to the economy. On the upside, a
renewal of financial and services support provisions under the Compact
Agreement would boost confidence. Prompt implementation of fiscal and
structural reforms could lift potential growth and ensure budget
self-sufficiency and fiscal sustainability.
“Looking ahead, economic policies should focus on supporting the recovery
and rebuilding fiscal resilience to cope with the possible fiscal cliff in
FY2024. Near-term policies should prioritize measures to protect the
vulnerable, accelerate the vaccination process, and underpin the economic
recovery. To ensure fiscal resilience, a comprehensive medium-term fiscal
policy approach that addresses the possible fiscal cliff and safeguards
debt sustainability is needed. Accelerating structural reforms would be key
to develop a dynamic private sector, diversify the sources of growth, and
adapt to climate change.
“Supportive fiscal measures should remain in place until the recovery is
firmly underway. This could be achieved by the extension of fiscal support
provided to the unemployed, low-income households, and informal workers.
The vaccination process should be accelerated to achieve collective
immunity as early as possible to safeguard the public health and enable a
gradual reopening of the economy. Efforts to execute existing commitments
on public infrastructure investment should also be increased to help
reactivate economic activity and strengthen the recovery as soon as the
borders are reopened.
“Once the recovery is firm, a gradual fiscal consolidation is warranted to
reduce fiscal risks related to the possible expiration of the Compact
Agreement and rebuild longer-term fiscal resilience. A gradual fiscal
adjustment of about 1-2 percent of GDP per year could be implemented over
five years when growth is expected to strongly bounce back and stay above
trend. The adjustment could be achieved through domestic revenue
mobilization and expenditure rationalization. In this regard, the
establishment of the National Tax Reform Commission to strengthen the tax
system, expand the revenue base, and ensure equitable revenue sharing is
welcome, and tax reforms should prioritize the introduction of a
value-added tax (VAT). State support programs and purchases of goods and
services could be streamlined and rationalized, while protecting social
spending and public infrastructure investment. Efforts to strengthen public
financial management (PFM) and public investment management (PIM) should
also be enhanced. Even if the Compact grants are renewed, some of the
recommended adjustments would be beneficial to make the tax system and
government spending more efficient.
“The FSM’s financial sector has so far remained resilient. Until the
recovery is underway, the near-term financial sector support such as the
interest payment relief and debt moratorium could be extended for viable
firms. Close monitoring of non-performing loans and broader credit quality
indicators such as restructured and doubtful loans is warranted as the
COVID-19 crisis is still evolving. More needs to be done to facilitate
financial development, including updating banking laws, adopting prudential
standards for banks, and speeding up structural reforms to ease the
bottlenecks to credit supply and demand.
“Tackling structural challenges to support private sector growth remains
critical to set the stage for a robust recovery and pursue sustainable and
inclusive growth. Reforms to help reduce business startup costs and time
for settling disputes, lowering the regulatory burden on foreign direct
investment (FDI), improving the efficiency of the judicial process,
enhancing coordination across states, and establishing a national single
window system for trade and FDI should be prioritized. ICT infrastructure
investment should be expediated to enhance digital connectivity, helping
overcome the geographical remoteness and expand economic opportunities.
“Improving climate resilience would help support the recovery, boost the
long-term growth potential, and mitigate climate disaster risks. There is a
need to swiftly develop an overarching National Adaptation Plan and
disaster resilience strategy. Improving access to climate finance should be
supported by stronger public investment implementation capacity. The recent
amendment of the FSM Trust Fund law, which mandates the fund to invest in
clean and green portfolio, is welcome and sends a strong signal of the
FSM’s call for green and low-carbon development.”
The team met with Finance Secretary Amor, Environment, Climate Change, and
Emergency Management Secretary Yatilman, Transportation, Communication, and
Infrastructure Secretary Apis, senior officials of the national government
and state-owned enterprises, the financial sector community, development
partners and private sector representatives. The team would like to thank
the Micronesian authorities for the constructive discussions and close
cooperation.
