1. FSM Economic Reviews JEMCO, August 2014
Graduate School USA, Pacific & Virgin Islands Training Initiatives
FSM Economic Reviews
JEMCO, August 2014 1

2. FSM Presentation Economic Performance Economic Policy
Compact Trust Fund 2

3. REAL GDP & Per Capita GDP
-0.4% GDP Growth from FY03 to FY13
-0.2% GDP Per Capita Growth
Decline during Compact adjustment phase due to lower grant levels, RIFs in Chuuk and Kosrae;
Improvement in 2nd phase after adjustment complete and large FAA projects and improving utilization of infrastructure grant
Very disappointing result in FY13 due to declines in FAA and infrastructure grant utilization and fisheries dry docking
Overall result -0.4% GDP decline during amended Compact
GDP per capita result not as bad as GDP indicating that given level of GDP spread over fewer people; perverse result due to decline in denominator rather that increase in numerator 3

4. Sources of Growth, FY09 to FY13
Graph indicates importance of major economic industries to GDP change
Construction dominant force in recent economic performance, fisheries also important,
Note: fisheries change is change in domestic fleet operation and not receipt of fishing fees.
In FY13 both construction and fisheries declined with FAA projects nearing completion and dry-docking of domestic fleet.
GDP declined not only at the FSM level but also in all FSM states: first time all states have declined since start of GDP time series
Size of impact of construction on the economy emphasizes the importance of improving infrastructure grant implementation 4

5. REAL GDP per Capita by State
Chuuk
Kosrae
Pohnpei
Yap
.6% Growth
1.3% Growth
.7% Growth
0% Growth
Significant income disparity in GDP per capita between FSM states, Yap 3 times Chuuk.
Growth in Pohnpei significantly higher 1.3% since 80s. Kosrae and Yap similar at 0.7/0.6%, but Chuuk experienced no change in GDP per capita over the period. 5

6. Net Migration (FY04 to FY12)
Migration has occurred in all states at approximately same rate. There appears to be general out migration reflecting wage and opportunity differences with the U.S.
Information based on US Dept. of Transport data; data problems in FY13 has undermined use of series as reliable indicator of migration, possible connections with United commencement of service
-7,082
-5,334
-15,197
-1,015
-1,766
-1.6% ANNUALLY 6

7. Net Migration & Net Employment
Graph shows levels of net migration change, and net employment; employment series is change in numbers on previous year.
Clearly close correlation between migration and domestic employment opportunities.
Difference between curves indicates migration is driven by forces other than employment change. 7

8. Net Migration & Net Employment
To emphasize close relation between migration and domestic employment opportunities employment scale has been expanded (doubled). 8

9. Employment by Sector -1.4% Public Employment Growth
-0.3% Private Employment Growth
During Amended Compact Period
-1.4% Public Employment Growth
Public sector employment was reduced significantly in FY07-FY09 with the impact of the RIFs in Chuuk and Kosrae and governments have held the size of government steady since that time.
Private sector also decline at the start of the amended Compact as falls in the economy and GDP reduced demand for private sector services and jobs.
In FY09-FY11 demand for private sector jobs picked up with strong demand from the construction industry, but declined in both FY12 and FY13 as the FAA projects neared completion and usage of the infrastructure grant declined sharply in FY13. 9

10. Real & Nominal Wage Rates
2.0% avg
-2.3% avg
2.7% avg
-1.7% avg
Wage rates rise in private and public sectors; public sector wages double the level of private.
Nominal wages rose by 2.0% and 2.7% in two sectors, but real wages adjusting for inflation have been declining reflecting the 4% average inflation rate during this period 10

11. Revenues vs Expenditures
surplus
2.8% gdp
$8.7m
In FY2004 FSM makes $30m contribution to CTF leading to large deficit
In early years of Compact governments run deficits as they adjust to new conditions of amended Compact; by FY08 process complete
After FY08 sharp increase in revenues and grants as FAA projects and growing use of infrastructure grant rises strongly.
Budgets are largely in balance during this period
In FY13 revenues and expenditures decline as both FAA projects and Infra grant use decline.
Significant surplus emerges in FY13 11

12. National & All States Fiscal Balance
$11.4m structural surplus
FY2012
$18.0m structural surplus
FY2013
Significant difference between fiscal position at the state and national governments;
General improvement in deficit in states as they adjust in early part of amended Compact. However, significant deficit persists, much reflecting use of trust fund in Yap ($3.2m in FY12).
National government starts to run significant surplus in FY12 due to large increases in fishing fees. Fiscal surplus = $7.9m and $11.2m in last two years
Adding in expenditures on legislative public projects structural surplus = $11.4m and $18m 12

13. External Debt & Debt Service
External debt and debt service as percent of GDP remain at very comfortable levels. Debt/GDP very low by world standards.
World Bank recently declared the FSM at ”high risk of debt distress”. Result based on standard Debt Sustainability Analysis (DSA). Post FY2023 FSM projected to suffer from insufficient resources to fund government operations. Model indicates FSM borrows on international markets to finance deficit. However, DSA unrealistically assumes FSM can borrow, and while states may suffer a very large fiscal contraction the FSM sovereign government (the national government) has significant surplus to support debt service
WB declares FSM grant only member. ADB loan program at risk and DSA analysis may discourage private investors. 13

14. Growth Scenarios (Real GDP Per Capita)
Dismal scenario based on 0.3% growth
At FSM economic summit in growth scenarios were outlined: sustained growth, low growth and dismal.
Dismal scenario sees economy growing at 0.3% per annum: FSM reluctant to reform and out migration high
During amended Compact, growth is below dismal scenario in adjustment phase, then improves, but falls below in FY13 14

15. FSM Policy Issues
Two “Umbrella” Policy Initiatives now driving the policy regime at national and state levels:
Long-term Fiscal Framework
The 2023 Committee & Forthcoming Action Plan 15

16. Long-Term Fiscal Framework
LTFF drives fiscal policy in each of the 4 states:
Expenditure discipline, including public sector wages
Tax reform remains a work in progress
Structural reforms—if needed
National burden sharing on the table
FY2014 expenditures cuts done; FY17 & FY20 may be necessary 16

17. 2023 Committee Action Plan Action Plan Forthcoming
National Government revenue buoyancy creates opportunity
Saving and investing substantial sums from FY15 – FY23
FSM-wide tax reform likely endorsed 17

18. FSM Policy Issues
PUBLIC SECTOR WAGES—BACKGROUND
Total wage bill had been rising unsustainably from FY2004 to ~FY2010
Wage bill discipline had varied across five governments but now stabilized
Wage bill “freeze” alone had not proven to be effective—broader policy discipline had been required
JEMCO Resolution freezing wage levels in health and education now “replaced” by LTFF commitments 18

19. Public Sector Wages 19 State outcomes previously tracked closely…
The issue is largely constrained now by LTFF commitments. 19

20. Govt Wage Rates by Fund Source
Gen Fund
2.6% growth
Federal
5.7% growth
Compact
2.2% growth
Federal programs are only 12 percent of the wage bill (Gen Fund: 44%, Compact 44%) 20

21. Revenues: National & All States
FY12-FY13 VDS $5,000/day
FY14 VDS $6,000/day
FY15 VDS $8,000/day
85% increase from 2004
1. FY11 was 37; …FY14 is projected at 77. (+$40 million) 21

22. FSM Policy Issues
TAX REFORM
Tax reform is an important component of long-term fiscal management
Clearly: greater local revenue effort results in proportionately reduced reliance on Compact flows (and Compact Trust Fund distributions)
Worst-case scenarios considered through the LTFF process would be mitigated in the presence of enhanced revenue efforts 27

23. Impact of Tax Reform Real Reduction vs Tax Reform Revenue
 FY13 to FY23:
(A) REAL Reduction
(B) Tax Reform Revenue
(B) as % of (A)
National
-$1.1
$1.9
166%
Chuuk
-$4.4
$1.7
39%
Kosrae
-$1.3
$0.5
40%
Pohnpei
-$2.9
$5.5
189%
Yap
-$1.8
$2.2
121%
FSM
-$11.5
$11.8
103% 28

24. Impact of Tax Reform Legislative Status of FSM Tax Reform URA RAA MOU
URA
RAA
MOU
NPT
Import VAT rate
GRT Repeal
VAT
National P Lp R
Chuuk
Kosrae
Pohnpei
Yap
URA = Unified Revenue Administration
RAA = Revenue Administration Act
Passed
Required
Not Required
Lapsed 29

25. FSM Policy Issues
LONG-TERM FISCAL FRAMEWORK: STATES
LTFF operational for second year—monitoring matrix being scrutinized across governments
FY15 and FY16 allow for modest inflation
FY17 calls for “contingent” expenditure cuts of ~6% in absence of major changes (growth, revenue reform, burden sharing)
Dilution vs Strategic Consolidation (was LTFF effective?)
Technical improvements need to be addressed prior to next round of participatory actions 30

26. FSM Policy Issues
LONG-TERM FISCAL FRAMEWORK: NATIONAL
National government faces a different fiscal picture: revenue buoyancy
Sensible options were identified as:
Saving for the future to reduce burden of adjustment—CTF
Tax reform and modified revenue/grant formulas with the states (gradually)
Investing (effectively) to reduce cost structure for state delivery of health and education services
Investing (effectively) in economic infrastructure to support private sector growth
2023 Action Plan May Meet/Exceed JEMCO expectations… tbd 31

27. FSM Compact Trust Fund
OBSERVATIONS
Recent strong market performance has improved outlook, but challenges remain for FSM especially;
Looming need to focus on “distribution policy” per TF Agreement Article 15(1). 32

28. FSM Compact Trust Fund 34

29. FSM Compact Trust Fund 35

30. FSM Compact Trust Fund 36

31. Questions or Comments? JEMCO-JEMFAC, August 2012
Graduate School USA, Pacific & Virgin Islands Training Initiatives
Questions or Comments?
JEMCO-JEMFAC, August 2012 61