Transcript Economic Challenges in the Federated States of Micronesia

Economic Challenges in
the Federated States of
Micronesia
International Monetary Fund
October 2005
Overview
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
What is the IMF and why are we here
FSM’s recent economic performance
FSM’s economic policy challenges
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Fiscal policy—including tax policy
Developing the private sector
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What is the IMF; why are we here?
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“The IMF is an organization of 184 countries,
working to foster global monetary cooperation,
secure financial stability, facilitate international trade,
promote high employment and sustainable
economic growth, and reduce poverty.”
Focus is on macroeconomic and financial stability
We’re in FSM at the request of the national
government to give our view on economic policies.
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Recent economic performance

Growth is recovering from the Compact stepdown
GDP Growth and Inflation (in percent)
10
GDP growth
5
Inflation
0
-5
-10
FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005
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Recent economic performance
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The Compact is the major influence on the economy:
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Recent economic performance
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Budget is improving too, but still deficit; BoP worsening
Current Account and Overall Fiscal Balance
(Percent of GDP)
10
5
Current account
balance
incl.official
transfers
Overall fiscal
balance
0
-5
-10
-15
FY1997 FY1998 FY1999 FY2000 FY2001 FY2002 FY2003 FY2004 FY2005
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Economic challenges
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Compact grants will decline, and disappear in 2024.
Will the trust fund be enough? Depends on reforms.
In our 2004 reports, we examine three scenarios:
1. Baseline: no fiscal or structural (growthenhancing) reforms
2. Fiscal: tax reform and spending restraint
3. Fiscal-Private Sector Development:
comprehensive reforms
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Economic challenges
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Only with comprehensive reforms is the fiscal situation
sustainable in the long run
Compact Grant and Assets Returns1
(Percent of GDP)
40
Compact grants
Assets returns
30
20
Baseline
Fiscal
Fiscal-Private Sector Development
10
FY2004 FY2008 FY2012 FY2016 FY2020 FY2024 FY2028 FY2032 FY2036 FY2040
1
Compact grants for 2004-23; and Compact Trust Fund and other assets returns from 2024.
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Economic challenges
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The risks of inaction include:
 Weak growth & deteriorating living standards
 A more painful adjustment down the road:
adjustment cannot be avoided given declining
Compact funds
Size and location are obstacles but:
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Yap is fast-growing and relatively stable
Small remote states have prospered with good policies
Need to move soon to avoid a more disruptive
future adjustment
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Economic challenges
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So, need to save for the future; and
encourage private-sector-led growth
How much to save?
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We estimate 3 percent of GDP
How to do this?
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Options are:
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Trim spending
Increase tax revenue
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Options for budgetary savings
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Spending: public wage bill remains high, despite
reductions (and longstanding freeze)
Public Sector Wages and Salaries/GDP (2004)
40
35
30
25
20
15
10
5
0
Kiribati
FSM
Palau
Marshall
Islands
Fiji
Solomon
Islands
Papua
New
Guinea
Samoa
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Options for raising revenue
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Tax revenues are low by regional standards
Tax Revenue/GDP (2004)
30
25
20
15
10
5
0
Kiribati Solomon
Islands
Papua
New
Guinea
Palau
Fiji
Samoa
Marshall
Islands
FSM
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Revenues are uniformly low
Tax Revenue Composition in Selected PICs (In percent of GDP )
Income
taxes
Solomon Islands
7.7
Fiji
6.2
FSM
3.1
PNG
14.6
Palau
5.3
RMI
8.9
Samoa
4.4
Vanuatu
0.0
Sources: IMF staff reports
Consumption International
tax and Excises trade taxes
8.5
7.8
6.2
4.5
3.1
3.2
5.8
2.5
5.3
7.2
8.9
5.8
14.0
3.6
0.0
7.9
Other
taxes
2.8
0.0
2.2
0.0
4.7
0.9
0.6
0.3
Total
24.0
21.0
11.1
22.3
21.9
23.3
18.7
22.6
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How to Boost Tax Revenue?
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Options:
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Higher tax rates
Broader base (e.g. eliminate exemptions for
noncash income and public enterprises)
A better tax system
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Better administration (e.g. centralized)
Better enforcement and incentives to pay
But need to keep it simple (capacity is limited)
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One option: a VAT with improved tax administration
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How a VAT Works
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Tax levied on value added: output minus inputs
To consumers: like GRT/import/sales taxes
Businesses: pay tax on sales, get refund on
inputs
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Example: buy $10 in rice, sell $15 in rice cakes
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 tax is levied on $5 ($15-$10)
10 percent tax = 50 cents (GRT: 6% of $15 = 90 cents)
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Why a VAT?
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Businesses have incentives to report
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 helps with compliance
And gov’t can cross-check tax reports
No “taxes on taxes” (growth-friendly)
But there are challenges too:
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Constitution: states levy consumption taxes
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 would need to coordinate among states
Must design carefully, and improve administration
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Frequently asked questions
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Isn’t a VAT too complicated for FSM?
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Isn’t this just a tax increase?
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A VAT is in place and working well in a number of
small economies (Cook Islands, Samoa)
No; burden won’t necessarily rise for everyone
What’s the alternative?
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Could just raise rates or broaden base, but then
need more spending cuts; and tax hikes could
worsen compliance and “tax-on-tax” problems
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Developing the private sector
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GDP growth remains low by regional standards
Real GDP Growth (1992-2002 average)
5
4
3
2
1
0
-1
-2
Samoa
Kiribati
Papua
New
Guinea
Fiji
Palau
FSM
Solomon Marshall
Islands Islands
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Is the cost of doing business
restraining growth?
Cost of Doing Business
70
Papua New
Guinea
65
60
Micronesia
55
50
Vanuatu
45
Palau
Marshall Islands
Kiribati
40
Samoa
Tonga
Fiji
35
30
0
1
2
3
4
5
6
Average Growth 2000-04
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Private Sector Development:
Why & How
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Why:
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With Compact grants declining, a large public sector
is not viable in the long run
Developing the private sector will help the fiscal
problem: more growth more revenue
How:
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Improve infrastructure to reduce cost of doing
business
Ease land use for production & as collateral
Streamline foreign investment regime
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Summary
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Major challenges are ahead
Steps are being taken in the right direction
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Tax reform tax force
Wage restraint
New bankruptcy law
Large contribution made to Trust Fund
But more remains to be done to avoid risks
And there is no other option
Comprehensive reform will not be easy
But countries that follow good policies do perform
better in the long run
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References
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IMF Staff Report for FSM, 2004
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IMF Selected Issues for FSM, 2004
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http://www.imf.org/external/pubs/ft/scr/2005/cr05103.pdf
IMF Regional Economic Outlook, 2005
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http://www.imf.org/external/pubs/ft/scr/2005/cr05104.pdf
http://www.imf.org/external/np/pp/eng/2005/092705.pdf
Swimming Against the Tide? An Assessment of the
Private Sector in the Pacific, Asian Development
Bank
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http://www.adb.org/Documents/Books/Swimming_Against_Tide/default.asp
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