Regions and Countries

	Table of Contents
p. 2 of 20 BACK | NEXT I. Country Performance Assessment A. Economic Performance Assessment B. Poverty Assessment C. Assessment of Socio-Environmental Performance D. Governance: Sound Development Management E. Implementation Assessment II. Country Operational Strategy III. Sector Strategies IV. Regional Cooperation V. Donor Activities and Aid Coordination VI. Cofinancing and Catalyzing External Resources VII. ADB’s Operational Program VIII. Economic and Sector Work Program IX. Local Cost Financing

Country Assistance Plans - Federated States of Micronesia : I. Country Performance Assessment

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A. Economic Performance Assessment

1. The real Gross Domestic Product (GDP) of the Federated States of Micronesia (FSM) rose by an estimated 0.2 percent in the fiscal year ending 30 September 1999. This slight increase in the aggregate level of economic activity ended three years of recession, but was not evenly spread across the four states. Indeed, the rise in GDP was entirely attributable to an increase in economic activity in Chuuk, where the private sector expanded strongly enough to more than offset a further decline in the contribution of government. Real GDP was stagnant in Kosrae and Pohnpei, and declined in Yap, although in the latter two cases private sector activity increased¹.

2. In spite of the preliminary encouraging signs, the country's medium-term economic outlook remains fragile due to possible reductions in Compact of Free Association² (Compact) grant funding. An overall balance of payments surplus of 8 percent of GDP was recorded in 1998. The financial holdings of the state and national governments, which serve as a measure of external reserves, increased to $61.7 million, which was sufficient for almost nine months cover of imports at the much-reduced 1998 level. The external debt level at the end of 1997 was $111.4 million, or 52.3 percent of GDP. The national and state governments had undertaken massive borrowing in the early nineties, but since then have refrained from new foreign borrowings except for loans from the ADB. Lately, the external debt burden has dropped sharply and will continue to drop until 2001 when the borrowings of the early nineties will have been repaid.

3. Projections of the consolidated general government accounts for 1998 showed a substantial increase in the current budget surplus to 11.3 percent of GDP, and an overall budget surplus of 0.7 percent (see Appendix 1, page 1). Exclusive of separation payments, the overall surplus rose to 9 percent of GDP. This represents an important step toward greater fiscal self-reliance, but further adjustments will be required. In 1998, domestic revenue of $69 million still only accounted for 62 percent of current expenditure. Combined with the modest economic growth and increased tax efforts, there appears to be clear improvement in tax revenue in FY99. Besides a relatively low tax level and a need for reinforcing the tax collection efforts, the remaining critical issues are reforming the existing gross revenue tax into a more equitable, comprehensive, and export-friendly tax such as value-added tax; more equitable share of fishery fees and financial revenue between the national and state governments; improving weak implementation capacity; and achieving more effective and efficient use of resources through newly-introduced performance-based budget processes.

4. No data are available on the inflation rate, but it will have tracked the US rate of 2.6 percent, as the US dollar is the currency in circulation and the United States is the dominant source of imports. Commercial banking deposits and loans changed little from the levels recorded since 1993. Deposits dropped and both consumer and commercial loans increased marginally, with the former loans (mostly to public servants) dominating bank portfolios. The loans to deposits ratio fell to 43 percent at the end of the 1999 fiscal year, as banks continued to invest offshore because of the ongoing lack of domestic commercial lending opportunities. The latter reflected a specific limitation on mortgage secured lending caused by a legal prohibition of land ownership by foreign banks. It also reflected a combination of constraints to private sector development in general, most notably high wage costs, inadequate economic infrastructure, and an inadequate regulatory framework and its application. Under the Public Sector Reform Program (PSRP)³ , a start has been made in the easing of these and other constraints through public service downsizing, public enterprise reform, support services, and attempts at improving land titling and leasehold arrangements.

5. The aid-dependent, public sector-dominated nature of the FSM economy is well documented. This has altered some with the cutbacks in government expenditure forced by reductions in transfer grants under the Compact with the United States. Staff retrenchment and wage reductions have brought about a reduction in national and state government expenditures from 80 percent of GDP in 1993 to 70 percent in 1998. Simultaneously, they have caused a decline in private sector activity (excluding subsistence production) since historically this sector largely evolved as a subsidiary goods and services provider to public servants, centering on importing, wholesaling, and retailing, rather than on export-oriented agriculture, fisheries, and tourism. The public expenditure reductions have contributed substantially to a strengthening of state government finances, but expenditure remains high, with wages and travel accounting for 85 percent of operating expenditure. The external debt level continued to decline in 1999, reaching 28 percent of GDP (compared with a high of 66 percent in 1993). The debt service ratio was estimated at 25 percent of exports. Official projections indicated that the country was on track to achieve a debt to GDP ratio of 21 percent and a debt service ratio of 3 percent by 2002.

6. The extent of the long-term economic adjustment required if large aid flows are not continued is indicated by the fact that, in 1998, Compact transfers still accounted for 47 percent of total government revenue. Tax collections provided just 14 percent. Major reform to improve efficiency and effectiveness is required if taxation revenue is to rise without jeopardising private sector development. This will involve consideration of a value-added tax as a replacement for the current gross revenue tax, greater efficiency in collection, and greater use of service charges and user fees. The issue of revenue-sharing between state and national governments needs to be addressed. Any reductions in external grants demand further fiscal adjustments that will impact negatively, and relatively quickly, on living standards. The private sector development that must be relied upon to generate employment and income will be slow in coming if many of the conditions, which are essential for investment and economic growth, are not addressed with increased vigor. At the 4th Consultative Group meeting held at the ADB headquarters in February 2000, the Government presented its plan for private sector-led growth of the FSM economy, which was consistent with ADB and other donors' proposed strategy for FSM.

7. The obvious uncertainty confronting FSM governments is the outcome of re-negotiations of the US Compact. If successful from a FSM perspective, there will be a long-term source of financial support but probably lower than in the past. The pressure for significant economic restructuring in the short-term will be eased and Micronesians may experience less compulsion to emigrate to Guam, Hawaii, and the US mainland in search of employment. If the re-negotiations are unsuccessful, there is still provision for grant transfers in 2002 and 2003 at the average level of the 15-year period 1986-2000, but then the economic situation will dramatically worsen. It is important for the Government to vigorously pursue policy actions for private sector-led development.

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