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GDP growth edged up to 2.0% in FY2007 (ended 30 September 2007) (Figure 3.34.9). The economy is dominated by the public sector, which accounts for 45% of GDP and employment, and the 2007 expansion was driven primarily by an increase in government capital expenditures from United States (US) $14.5 million in FY2006 to US$21 million in FY2007. Emigration has accelerated over the past decade or so, but private transfer receipts fell from 0.5% of GDP in 1997 to 0.3% in 2006.
The budget is heavily dependent on funds from the US under the amended Compact of Free Association FY2004–FY2023, with domestic revenues funding only 45.6% of current expenditures in FY2007. An overall budget deficit of 0.7% of GDP in FY2007, compared with a surplus in FY2006, reflected the increase in capital expenditures. Weaknesses in fiscal management remained apparent, with domestic revenues falling slightly and little reduction in a public service wage bill that accounted for 42.6% of current spending and involves pay rates that are higher than the private sector. The weak revenue performance was aggravated by a high noncompliance rate of 30–40% in tax payments, which causes annual revenue losses of US$8 million–10 million.
Although the amended Compact agreement specifies annual declines in Compact grants, there has been little advance planning for these adjustments in the country. A tendency to use Compact funds to support public sector activities and jobs, rather than to facilitate private sector development, has constrained economic growth, and thus the prospect of significantly reducing reliance on external support.
The International Monetary Fund considers the economy to be at high risk of debt distress, with a ratio of net present value debt to GDP of 75% in 2007, and debt service as a share of exports at 32.3% in 2006 (Figure 3.34.10). Scheduled debt service obligations are underbudgeted and repayments sometimes delayed. Furthermore, additional loans, albeit on concessional terms, fall due for repayment over the next 5 years. One option to reduce the fiscal pressures would be to reform and downsize the public sector.
Some noteworthy efforts to pursue private sector development in 2007 included the introduction of legislation to allow for competition in telecommunications with the Government's National Telecommunications Authority. Internet costs are among the highest in the Pacific, at US$190 for 50 hours. In other developments, construction started on a fishprocessing plant, which should revive tuna loining this year; and the country was removed from the List of Uncooperative Tax Havens by the Organisation for Economic Co-operation and Development in mid-2007.
This economy usually runs a deep trade deficit (Figure 3.34.11), which is covered by inflows on the income and transfers accounts, especially Compact grants and payments associated with the US military base at Kwajalein atoll. The US dollar is the domestic currency, so inflation is influenced by trends in the US. In FY2007, inflation was 3.4% (Figure 3.34.12) and is expected to remain at around this level in FY2008.
Stumbling blocks to private sector investment include problems with access to finance and land, ineffective laws and regulations, poor infrastructure, and policy shifts. An election in late 2007 resulted in a change of government and some uncertainties in the policy environment. A decline in Compact grants scheduled for FY2008 and FY2009 will have a damping effect on economic growth, offset in part by the new tuna-loining plant. Annual GDP growth of around 1% is projected. |
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