Republic of the Marshall Islands : Staff Report for the 2013 Article IV Consultation

KEY ISSUES Context. The Republic of the Marshall Islands (RMI) is going through a period of output fluctuations. The economy expanded in FY2012 by 3.2 percent, supported by export growth, but in FY2013 is estimated to have slowed to 0.8 percent due to the postponement of infrastructure projects. A fiscal deficit of 0.8 percent of GDP was recorded in FY2012 and another deficit of similar magnitude is estimated for FY2013. Outlook and Risks. A growth rebound is expected in FY2014, assuming the resumption of infrastructure projects. A sustained increase in growth is hindered by the scheduled reduction in Compact grants and limited private sector expansion. Near-term risks are on the downside, stemming from possible further delays in project implementation. Insufficient fiscal buffers and public contingent liabilities constitute key risks for the medium-long term. Policy Issues. The RMI faces persistent budget deficits, substantial fiscal risks from poorly performing state-owned enterprises (SOEs) and the social security system, and the expiration of most Compact grants after FY2023. Private sector development is limited by remoteness, small market size, SOE dominance in some sectors and a weak business climate, constraining growth, and making fiscal sustainability more challenging. Household debt and debt service ratios are high, while the supervisory power and capacity of the Banking Commission is hindered by institutional and resource constraints. Key Policy Recommendations. A fiscal adjustment of no less than 4.5 percent of GDP by FY2018 is needed to achieve longterm budgetary self-reliance and to build some fiscal buffers, taking the trade-off between consolidation needs and growth implications into account. Achieving this target would require public wage moderation, SOE restructuring, swift implementation of the long-awaited tax reform and further reforms to the social security system. Growth potential can be enhanced by upgrading human capital and infrastructure and securing better connectivity, in cooperation with development partners and neighbor countries. SOE reforms and measures to facilitate firm access to credit would support private sector development. The capacity and oversight authority of the Banking Commission should be strengthened to safeguard financial stability