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

KEY ISSUESContext. The Republic of the Marshall Islands (RMI) is going through a period of outputfluctuations. 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 ofinfrastructure projects. A fiscal deficit of 0.8 percent of GDP was recorded in FY2012 andanother deficit of similar magnitude is estimated for FY2013.Outlook and Risks. A growth rebound is expected in FY2014, assuming the resumption ofinfrastructure projects. A sustained increase in growth is hindered by the scheduled reductionin 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 andpublic contingent liabilities constitute key risks for the medium-long term.Policy Issues. The RMI faces persistent budget deficits, substantial fiscal risks from poorlyperforming state-owned enterprises (SOEs) and the social security system, and the expirationof 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, constraininggrowth, and making fiscal sustainability more challenging. Household debt and debt serviceratios are high, while the supervisory power and capacity of the Banking Commission ishindered 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 longtermbudgetary self-reliance and to build some fiscal buffers, taking the trade-off betweenconsolidation needs and growth implications into account.Achieving this target would require public wage moderation, SOE restructuring, swiftimplementation of the long-awaited tax reform and further reforms to the social securitysystem.Growth potential can be enhanced by upgrading human capital and infrastructure andsecuring better connectivity, in cooperation with development partners and neighborcountries. SOE reforms and measures to facilitate firm access to credit would supportprivate sector development.The capacity and oversight authority of the Banking Commission should be strengthened tosafeguard financial stability.