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Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia

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Marshall Islands

Growth in the economy was minimal in 2001, and was based largely on limited expansion in private sector activity.

A temporary increase in funding through the Compact of Free Association with the US is likely to result in some economic growth in the near term.

Macroeconomic Assessment

The economic difficulties of recent years continued into 2001, with estimated GDP growth slowing to only 0.6% from 0.7% in 2000. A contraction in government expenditures was brought about by the need to adjust to a downward trend in revenues and to repay the high debts accumulated over the 1990s. A positive factor was some, though limited, expansion in private sector activity due to a small rise in copra exports and the first full year of operation of a tuna processing plant. Consumer price inflation was relatively stable over the year at an estimated 2%, and is largely attributable to the low level of inflation in the US. (The US dollar is the country’s currency.)

Total revenues and grants are estimated to have grown by over 13% in fiscal year 2001 while expenditures rose by just under 2%. This resulted in a budget surplus of about 17.5% of GDP, and marks a continuation of recent trends. The large surplus was required to meet large principal repayments that peaked in fiscal year 1999 at $42 million and were estimated at $25 million in fiscal year 2001 (Figure 2.31). This compares with total revenues and grants of $66 million and $84 million in fiscal years 1999 and 2001, respectively.

The Marshall Islands’ export base is very narrow, with estimated exports of $8 million in fiscal year 2001 heavily outweighed by projected imports of about $60 million. Such a high level of imports is made possible by the provision of substantial financial assistance by the US under the Compact of Free Association.

Copra provides the main source of exports and of income on the outer islands. It also supports a small manufacturing operation in Majuro where it is processed into coconut oil and other products. Despite a government price subsidy, exports have trended downward in recent years. The income gained from the sale of fishing rights provides the main source of nontax revenues, amounting to approximately $3 million in fiscal year 2001. Tourism numbers are very small at around 2,000–3,000 visitors a year, and make little contribution to foreign exchange earnings.

The formal finance sector consists of two foreign commercial banks, one domestic commercial bank, and one national development bank. Local conditions determine interest rates despite the use of the US dollar and the absence of exchange controls. Commercial bank reserves are ample at around 44% of assets. Nonperforming loans are not a major issue for the commercial banks but are a problem for the development bank, which has suffered in the past from political interference and poor management.

Policy Developments

External debt repayment requirements will fall substantially in fiscal year 2002 and remain considerably lower than in recent years. The Government intends to allocate at least 60% of the resources freed by the decline in external debt servicing to the Marshall Islands Intergenerational Trust Fund, which is also intended to receive contributions from the US and other donors in the future. The Government allocated $14 million to the Fund in 2001; and, under one scenario, the Fund would reach $750 million within 20 years and thereafter provide a regular income flow of around $30 million–$40 million a year (in nominal terms). This compares with a GDP of about $100 million in 2001.

Tax revenues have fallen in recent years following the reduction in fiscal year 1998 of general import duties from 10–12% to 5%. Total import duties have fallen by around $3 million a year. The potential exists to replace these lost revenues through a broad-based sales tax as a substitute for an existing turnover-type tax. A simple VAT was proposed for implementation in 1996 but this did not materialize. Other reasonable means for strengthening the fiscal position include the reduction of subsidies to government-owned enterprises, the adoption of (means-tested) co- payments for overseas medical referrals, and the collection of unpaid social security taxes.

Outlook for 2002-2003

The pace of growth in 2002 will be about the same as in 2001, while the outturn for 2003 will depend upon Compact negotiations. Inflation in 2002 will remain about the same as in 2001.

The Marshall Islands receives considerable direct US assistance, currently averaging around $35 million a year, the vast majority of which is in the form of direct budget support under the Compact. The availability of such support over many decades, combined with limited local resources, has created a heavy economic dependence on the Government. This dependence has inhibited the development of the fundamentals required for economic growth, from education attainment to entrepreneurial drive. Autonomous expansion of the private sector is very unlikely. Developments in the public sector, notably the future level of US funding, will continue to drive the economy over the medium term.

The financial arrangements contained in the Compact were to be revised by October 2001. However, the Compact provided for a 2-year extension and this has secured a higher level of assistance than in the last 5 years, known as “bump-up” funds. This will increase direct budget support to $37 million annually in fiscal years 2002–2003. Assisted by this, the 2002 budget provides for an increase in expenditures from $66 million in fiscal year 2001 to $74 million. This can be expected to help sustain economic activity over the year.

Negotiations on the future level of support are continuing and the extent of adjustment that will be required post-October 2003 is unclear at this stage. In light of this impending change in revenues, it is important that expenditures, particularly recurrent expenditures, are kept to long-run sustainable levels. However, the 2002 budget provides for an increase in recurrent expenditures to $59 million from $55 million. Fiscal responsibility will probably require this to be reversed over the medium term.

The Compact provides the Marshallese with the right to work in and emigrate to the US, and there has been a steady outflow of citizens during the 1990s for this reason. While emigration will tend to encourage the most qualified people to leave the country and so depress economic activity, the option at least provides a safety valve and safeguards the quality of life for the remaining Marshallese, even if a large contraction in the public sector becomes inevitable.

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