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p. 41 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia The Pacific Cook Islands Fiji Islands Kiribati Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Tonga Tuvalu Vanuatu III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia

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Federated States of Micronesia

The economy grew by 2.5 percent in 2000, led by manufacturing, construction, and transport. Recent reforms helped it to return to positive growth in 1999 and expansion is expected to continue in the medium term. Long-term prospects depend on how the economy moves toward becoming more self-reliant.

Recent Trends and Prospects

Real economic growth in the Federated States of Micronesia (FSM) was estimated to have accelerated to 2.5 percent in 2000, from 1.3 percent in 1999 (see Figure 2.22). The Public Sector Reform Program implemented in the latter half of the 1990s facilitated the return to growth in 1999. The largest contributors to the improvement in 2000 were manufacturing, construction, and transport.

The overall consolidated general government balance in 2000 was an estimated surplus of 0.4 percent of GDP. Total revenues were $152.8 million, out of which $96 million (42 percent of GDP) were grants. Further, $79.4 million of these grants were given under the Compact of Free Association with the US. The value of exports is estimated to have more than doubled in 2000 to $23.5 million, mainly as a result of higher fish exports. Fishing access fees were $16.8 million, similar to the 1999 level. Receipts from tourism changed little. The value of imports increased in 2000 on the back of stronger GDP growth. The trade balance remained at a considerable deficit, rising to an estimated $122.3 million in 2000. Including official transfers, the current account surplus deteriorated from $55.7 million in 1996 to $6.5 million in 2000 due to the second step-down in the Compact funding level in 1997 (the first was in 1992). The country has gradually reduced its external debt from $137 million in 1993 to $85.7 million in 2000. Inflation has, in recent years, been running at generally low levels, with the figure for 2000 estimated at 2.8 percent.

Modest economic growth is expected to continue in 2001 and 2002, led by manufacturing, construction, and transport, and inflation is likely to remain subdued provided that US inflation remains low. The use of the US dollar as the unit of exchange means that, on the external account, the FSM’s external debt position is likely to be favorable, with a debt-to-GDP ratio of 21 percent in 2001. The value of fish export receipts is expected to increase in 2001, largely due to anticipated movements in tuna export prices. Overall, however, the short-to medium-term outlook for exports is modest. The debt in 2002 is forecast to be $53.8 million, with a debt-service ratio of 4.5 percent of exports of goods and services. The current account is likely to turn negative in the short term. Tourism is the sector with the greatest growth potential in the FSM. However, visitor arrivals fell in 1997 and 1998, partly as a result of the Asian financial crisis. The decline continued in 1999 and 2000, with visitor numbers totaling 17,477 and 17,152, respectively. This tourism potential will, however, only be realized once further reforms have made the foreign investment environment more attractive, including, particularly, a transparent, open regime.

Issues in Economic Management

The Government has made concerted efforts to address some of the key economic challenges facing the country, particularly since the second step-down in Compact funding. Yet a range of significant issues remains. Fiscal management at the national level is a serious concern, as the national Government has continued to run fiscal deficits by drawing down from fund balances invested abroad.

As the currency is the US dollar, fiscal policy is the major macroeconomic tool available to the Government. Domestic adjustments in response to lower resource transfers, therefore, are based on cutting government expenditure, reducing public sector employment and wages, and increasing domestic revenues. The Government needs to further adjust public sector taxation and increase its taxation effort. Domestic revenue efforts remain low, although the likely introduction of a value-added tax is expected to provide a nondistortionary broad base for revenue generation. However, further fiscal adjustments will be required.

Renegotiations on the Compact were undertaken in 2000. Their outcome, along with the timing of their completion, are both significant factors for short- to medium-term economic management. If the negotiations are not complete by November 2001, the Compact provides for a further two years of funding at the level received at the end of the first step-down in 1992. This will result in an increased funding of around $34 million over the two years 2002 and 2003. These funds might best be used as a reserve against future shocks and could be used as initial capital for a proposed trust that the Government has asked the US to fund.

Policy and Development Issues

The Government faces several challenges, including the need to ensure strong growth in the private sector. It should, therefore, divest itself of public sector enterprises in the fisheries sector and allow the private sector to identify opportunities and take commercial risks.

The traded goods sectors of commercial agriculture, fisheries, and tourism play a very small role in the economy. Yet these are the sectors in which the economy has some comparative advantage, and which provide medium- and long-term growth potential. Given the objective of achieving financial self-sufficiency, rapid growth in these export sectors must be a focus of government policy, including promotion of foreign direct investment in tourism.

While government employment remains significant, it declined from 6,390 in 1997 to approximately 5,200 in 2000. Formal private sector employment increased over the same period and, in 1999, for the first time exceeded that in the public sector. Overall, however, growth of formal private sector employment remains modest, and the challenge facing the Government is to boost such growth.

Despite some remittances from overseas migrants, the number of low-income households is still high. Although the FSM does not produce a poverty profile as such, recent household income and expenditure surveys suggest that around 40 percent of households could be considered as low income. Furthermore, the lowest-income households are on the outer islands where opportunities for formal sector employment and commercial activities are few. The Government needs to address these disparities.

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