Catalog

Federated States of Micronesia

The economy contracted for a fourth year in a row, with GDP falling by 2.5% in 2007. The decline was most marked in the states of Chuuk and Kosrae, where past financial management deficiencies are now requiring severe fiscal contraction. The economic deterioration also reflects the impact on public current expenditures of cuts in US funding under the amended Compact of Free Association, of underspending of grants, and of difficulties on the part of national and state governments in meeting specific requirements to access infrastructure development and capacitybuilding funds provided by the Compact.

A contracting public sector also hurts private sector activity, given that government and public enterprises account for 38% of GDP and 51% of paid employment. The weak economy of recent years is reflected in a decline in living standards and in emigration. Between 2003 and 2007, GDP per capita fell from US$2,015 to US$1,840 (Figure 3.34.13), and emigration has averaged 1.8% of the population a year since 2001.

Inflation slowed to 2.8% in 2007 (Figure 3.34.14), after exceeding 4% for 2 years when taxes on alcohol and tobacco had been raised. The use of the US dollar as domestic currency kept domestic interest rate trends aligned with those in that country.

US Compact funding provides about 65% of revenues for the national Government and 75% of revenues for the states, and is the major component of the balance of payments. The decline in Compact funding is matched by a commensurate increase in US support to the FSM Trust Fund, which is to act as a post-Compact fiscal support mechanism. The country is now struggling to raise the revenues required to support public sector operations, which involve paying wages that are well above those in the private sector. Past efforts to reduce the size of the public sector have had limited success, and progress in adjusting to lower Compact funding has been minimal.

This deteriorating fiscal situation is masked by increases in bilateral grants from the People's Republic of China and, to a lesser degree, Japan. Despite the extent of the public service sector, the Government lacks the capacity to adequately monitor and report on Compact expenditures and performance, which holds back access to some funds, particularly those for infrastructure. Moreover, its ability to implement infrastructure works is limited, even if funds become available.

The consolidated budget deficit narrowed to 2.7% of GDP in FY2007 (ended 30 September 2007) (Figure 3.34.15), but the financial positions of Chuuk and Kosrae states remain precarious. Chuuk has planned an adjustment strategy but there has been little progress in its implementation. Kosrae has adopted a strategy to reduce state employment.

The external debt position remained sustainable in FY2007, with gross external debt equivalent to 25.1% of GDP and debt service equivalent to 6.0% of exports of goods and services. There are concerns, though, that state government contingent liabilities might be significantly underreported and that expected additional debt could place further pressures on fiscal stability.

The economic decline is likely to continue in 2008 and 2009, with GDP contracting by 3.5% and 3.0%, respectively. The outlook could improve in the medium term if Compact infrastructure funds were released. Achieving sustainable growth will depend on the Government's ability to drive reforms that support new private sector development in the face of opposition to liberalization of investment policy. In particular, tourism and fisheries have development potential, provided that barriers to mobilizing land and to allowing foreign investment can be overcome.