June 19, 2019

End-of-Mission press releases include statements of IMF staff teams that convey preliminary findings after a visit to a country. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF's Executive Board for discussion and decision.

• The economy of the Federated States of Micronesia (FSM) has performed well in recent years with moderate inflation.
• While the economy performed well in recent years, uncertainty regarding the post-2023 relationship with the United States poses significant macroeconomic challenges ahead.
• To cope with the challenges, it is time to start a gradual fiscal adjustment, increase resilience to climate change, strengthen financial sector supervision, and vitalize the private sector.

An International Monetary Fund (IMF) staff team led by Masahiro Nozaki visited Pohnpei during June 4-17, 2019, to hold discussions for the 2019 Article IV Consultation. A joint IMF and World Bank team conducted a Climate Change Policy Assessment during June 10-17 and contributed to the Consultation. At the end of the mission, Mr. Nozaki issued the following statement:

“The economy of the Federated States of Micronesia (FSM) has performed well in recent years. GDP growth has remained higher than its historical average, albeit slowing from 2.4 percent in FY2017 (ending September 2017) to 1.2 percent in FY2018 due to a contraction in construction. Employment growth has also remained higher than the historical average. Over the medium term, growth is projected to converge to its potential rate, estimated at 0.6 percent, in line with the FSM’s performance over the last two decades. Inflation has remained low and is projected to stay at 2 percent over the medium term, owing to the use of the U.S. dollar as legal tender.

“Risks to the outlook are tilted to the downside. Unless economic supports under the U.S. Compact Agreement are renewed, the FSM is expected to lose access in 2023 to U.S. Compact grants, banking sector oversight by the U.S. Federal Deposit Insurance Corporation (FDIC), and post-disaster rehabilitation assistance by U.S. federal agencies, resulting in substantial macroeconomic uncertainty. Moreover, the impacts of climate change including through more frequent natural disasters remain a major downside risk. On the upside, decisive progress in pro-growth structural reforms can raise potential growth, and renewal of the economic supports under the U.S. Compact Agreement would reduce downside risks.

“Now is the time for action to reduce the post-2023 uncertainty. Policy priorities would consist of starting a gradual fiscal adjustment, accelerating implementation of measures to increase resilience to climate change, strengthening financial sector supervision, and accelerating efforts to develop a vibrant private sector.

“With U.S. Compact grants expected to expire in FY2023 under the current arrangement, a government deficit of about 4-5 percent of GDP would emerge in FY2024. To cope with this challenge, a gradual fiscal adjustment of 4-5 percent of GDP through 2023 is warranted to minimize fiscal financing needs. The adjustment should be carried out by growth-friendly tax measures and rationalization of nonessential expenditures, while protecting spending on education, healthcare, and infrastructure. Future revenue windfalls should be saved to strengthen fiscal resilience. In this regard, the authorities’ decisions to save the revenue windfalls during 2017-18 into the FSM Trust Fund are commendable.

“The FSM is highly vulnerable to climate change. Rising sea levels and temperatures threaten livelihoods and are compounded by the rising frequency and intensity of natural disasters. Building resilience requires swift implementation of the Infrastructure Development Plan, supported by stronger public investment implementation capacity. Making greater use of disaster risk transfer mechanisms, including disaster insurance and contingent foreign financing, can help strengthen the government’s ability to respond to natural disasters. Incentivizing lower carbon usage and encouraging further use of renewables can help the FSM to meet its Paris Agreement pledges on greenhouse gas emissions.

“Strengthening banking sector supervision is important to cope with a possible reduction in banking sector oversight by the U.S. FDIC in 2023. Efforts should be stepped up to update banking laws, adopt prudential banking regulations, and develop a reform roadmap to strengthen the Banking Board’s supervision of commercial banks.

“Vitalizing the private sector is critical to shore up potential growth and navigate the FSM through the post-2023 uncertainty. Lowering business startup costs, reducing time for settling disputes, and digitalizing the land registry can improve the business climate. Foreign direct investment (FDI) should be promoted by harmonizing FDI laws and regulations across states and establishing a national single window for FDI.

“The team met with Finance Secretary Lawrence; Environment, Climate Change, and Emergency Management Secretary Yatilman; Research and Development Secretary Henry; senior officials of the national government, the state government of Pohnpei, and state-owned enterprises; the financial sector community; development partners; and private sector representatives. The team would like to thank the Micronesian authorities for candid and engaging discussions, close cooperation, and hospitality.”