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p. 55 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions I. Developing Asia and the world II. Economic trends and prospects in developing Asia East Asia Southeast Asia South Asia Central Asia The Pacific Cook Islands Fiji Islands Kiribati Republic of the Marshall Islands Federated States of Micronesia Nauru Republic of Palau Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia

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Republic of the Marshall Islands

The economy contracted in 2004 because of delays in implementing an upgraded public works program and the closure of the single largest private sector employer. A large step-up in central government expenditures and net lending, funded through increased US grants, has been budgeted for the medium term. This has the potential to support the economy over the coming years.

Macroeconomic assessment of 2004

A new financial agreement with the US Government under the Compact of Free Association was effected in FY2004 (ended 30 September 2004). This increased government allocations to additional recurrent and capital expenditures by 20%. The US commitment to long-term financial support after an extended period of negotiation was also expected to raise the confidence levels of households and private businesses. Apart from this, a major hospital upgrade funded by a grant from the Japanese Government was under way in the capital, Majuro. These positive factors were initially projected to increase GDP over 2004. However, delays in implementing government capital projects and the closure of a tuna loining plant--the single biggest source of private sector employment--outweighed the expected boost in GDP, resulting in an overall contraction of the economy.

The main government projects to fall behind schedule were in education. The sector should have received 60%, or $12 million, of the year’s capital and maintenance budget for work on four high schools and an elementary school. However, government departments had some trouble in adapting promptly to new procedures designed to strengthen accountability and increase value for money, which resulted in a large carryover of work to FY2005. The tuna loining plant closed in August 2004 because of financial difficulties. The plant had unsuccessfully pursued a switch from the production of tuna loins to tuna steaks, which would have reduced the workforce by about 50%. The closure will see the loss of annual exports that were worth $3.4 million in 2003, representing more than half of merchandise exports (excluding reexports). Employment at the plant ranged between 500 and 600 people, some 5% of the economically active population, most of whom were women. It is estimated that, once indirect linkages are taken into account, the plant contributed as much as 3% of GDP.

Another contractionary impact on the economy came from a decline in visitor arrivals to 74% of the 2003 level. Projected annual tourist arrivals of 1,400 people in the year to September 2004 continued to be less than the number of business travelers, which is estimated to have reached 2,250 people in 2004. A positive contribution to growth was made by copra, which provides one of the largest sources of merchandise exports and cash incomes for the outer islands. Copra export volumes rose by 14% over 2004 and, with producer prices rising slightly, producer income rose by 16%. Total producer income from copra of $1.2 million contributed approximately 1% of GDP.

Following budget surpluses in FY2002 and FY2003 aimed at generating savings for investment in the Marshall Islands Intergenerational Trust Fund, the Government planned a substantial increase in expenditures and net lending in FY2004 and projected a small budget deficit of 0.6% of GDP. However, delays in capital works resulted in a budget surplus. Domestically raised government revenues, which accounted for a quarter of total revenues and grants, fell by 5% in FY2004 as income taxes and import duties declined by 12% and 6%, respectively, and receipts from the sale of fishing rights plummeted by 47%. These falls were offset by an increase in grants from the US and Taipei,China; but total revenues and grants nonetheless fell by an estimated 1% over FY2004.

Inflation for the 12 months to September 2004 picked up slightly from the previous year but only to 2.4%. The increase was mainly a result of higher fuel costs and, to a lesser extent, higher alcoholic beverage prices following a rise in import duties. Commercial bank lending strengthened by 8% to $45 million in 2004, but remained substantially less than deposits, which rose by 3% to $81 million. Lending rates at the two commercial banks remained steady at approximately 20% for consumer loans and 15% for business loans, while deposit rates of 3% provided for a very large interest rate margin.

Macroeconomic policy developments

The amended Compact of Free Association financial assistance package as formally agreed with the US Government in December 2003 represents a major change in financial relations between the two countries. It affects the level of funding, the allocation of funds, and internal systems for managing public funds. With regard to allocation, the package provides for a large shift of expenditures toward the main sectors of health and education as well as for capital improvement and maintenance (Figure 2.28).

The environment and the private sector are also priority areas. This marks a substantial change in direction for the public sector and reflects concerns held in the Marshall Islands and the US as to the development impact of the initial assistance package provided under the Compact. Even with the additional grants provided by the new assistance package, funding to the priority areas must level off in FY2006 to stay within the budget constraint.

The large increase planned in capital expenditures is important to correct for a backlog of projects. Capital spending has been curtailed for the past 5-6 years, initially by the need to repay high-cost government bonds and then by the need to save for investment in the Intergenerational Trust Fund. The rapid increase in capital expenditures requires an accompanying increase in recurrent funding (e.g., for teachers, medical staff, and medications) to make effective use of the facilities. The additional recurrent needs are yet to be fully factored into the medium-term fiscal framework, and some adjustments may be required to expenditure plans or internal revenue collection over the medium term to do this.

The amended assistance package provides for the adoption of financial accountability and management standards similar to those expected of US state and local governments. The Government recognizes that meeting these standards will require a sustained effort both to tailor systems and procedures to the circumstances of the Marshall Islands and to upgrade the capacity of its staff. Implementation of a government decision to move to performance-based budgeting is in its second year, with an initial emphasis on the ministries of Education, Health, and Environment. A medium-term budget and investment framework has also been established to shift budget planning to a 5-year rolling basis.

The Intergenerational Trust Fund had a balance of over $30 million at the end of FY2004, and this is to be built up in future years through $7 million in annual contributions by the US and ongoing contributions by the national Government. Ultimately, it is intended that the fund will provide a source of income sufficient to replace US grants. Against the assets in the fund, the Government held a debt of $100 million at end-FY2004, most of which was on concessional terms with ADB. The net debt of 65% of GDP should decline quickly over the medium term, as additional savings are made in the fund.

Outlook for 2005-2007 and medium-term trends

As the projected ratio of expenditures and net lending to GDP is more than 80%, the public sector will remain the dominant influence on the economy. Sufficient grants have been secured to maintain the high level of expenditures budgeted for FY2004, and this is expected to support the economy over the next few years. The Government’s change in focus to the priority areas for development is also expected to enhance growth potential and help lift activity.

A planned catch-up in capital works in 2005, in addition to the ongoing upgrading program, has the potential to provide a short-term boost to the economy. However, there is some risk that the tighter procedures now applied to capital works will result in continued project delays. Feasibility studies are now being conducted for major projects. External project managers are appointed to oversee work, and new tendering and contracting processes are in place. The new procedures have already resulted in benefits such as the contracting of major works at figures substantially below estimated costs. However, the downside is the slow rate of project implementation.

Action is being taken to reopen the tuna loining plant. As guarantor of a $2 million loan to the business, the Government acquired control of the plant after its closure and began investigating potential market interest in reopening it. The previous operator argued the plant was only commercially viable with tax concessions and a wage below the legislated minimum. If a prospective operator shares this assessment, it may take some time to negotiate a new commercial arrangement and recommence operations.

In January 2005, Aloha Airlines of Hawaii canceled its services to the Marshall Islands as part of a wider withdrawal from the region. While the country is still serviced by three international carriers, this reduction in capacity and competition on the major US route is a setback for tourism. This follows the recent withdrawal of the international Outrigger Group from the operation of the country’s main hotel.

The commercial banking sector remains constrained by the small private sector and an inability to use land and other assets as collateral for loans. However, revised land registry legislation and a strengthening of land management and administration are being pursued to ease the constraints faced by the sector.

Vocational training faces an uncertain future. A 2-year probation period set by US accreditation agencies for the College of the Marshall Islands was extended in January 2005 by 6 months, over which time the College must continue to correct shortcomings in financial management and strategic planning. If accreditation is removed, the College would lose approximately half of its revenues (via the loss of US grants) and require a substantial increase in local financial support to remain in business. Even if operations were continued, the loss of accreditation would reduce the ability of locally trained nurses, teachers, and business administrators to gain employment in the US.

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