IMF Concludes 2021 Article IV Consultation with Federated States of Micronesia

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation ^[1] with the Federated States of Micronesia (FSM) on October 27, 2021.

The FSM economy had performed relatively well before the pandemic but the global COVID-19 outbreak and related containment policies are putting strains on the economy. Growth reached 1.2 percent in FY2019 (October 1-September 30) owing to a strong rebound of construction activity, particularly public infrastructure investment. A public health emergency was declared and international travel restrictions were adopted at the onset of the pandemic, and subsequently extended through end-January 2022. Thanks to these measures, there has been no confirmed COVID-19 case in the FSM so far (as of October 5, 2021). However, domestic services activity has contracted sharply, planned investment projects have been delayed, and real GDP is estimated to have declined by 1.8 percent in FY2020.

The economic contraction is likely to deepen in FY2021 and a slow recovery is projected for FY2022. Once the pandemic fades, real GDP is expected to recover to the pre-COVID level in FY2024. Inflation is expected to rise in FY2021 due to higher imported prices including for commodities, before converging to U.S. levels of around 2 percent over the medium term. Fiscal and external balances are projected to remain in surplus in FY2021-22.

Uncertainty surrounding the outlook remains high, and risks are tilted to the downside. A prolonged border closure due to the pandemic or a possible domestic outbreak could extend subpar economic growth. Uncertainty related to the expiration of financial support and public services under the Compact of Free Association Agreement with the United States by end-FY 2023 could undermine investor confidence and weigh significantly on the medium-term economic prospects. Given the country's geographic dispersion and isolation, climate change-induced natural disasters remain a key downside risk to the economy. On the upside, a renewal of support under the Compact Agreement would boost confidence and shore up potential growth.

Executive Board Assessment [2]

Executive Directors commended the authorities for their strong and swift policy response to the pandemic, which successfully prevented a local outbreak and helped cushion the economic downturn. Directors were encouraged by the prospects for a recovery in the coming year, subject to high uncertainty. They noted macroeconomic risks stemming from the possible expiration of the Compact Agreement with the United States as well as the economy's vulnerability to climate change. Against this backdrop, Directors emphasized the need for policy actions to mitigate risks and facilitate stronger, greener, and more sustainable growth.

Directors emphasized that a coordinated and well-targeted policy response to support the economy and the most vulnerable remains a priority until the recovery is firmly underway. They welcomed the authorities' commitment to ensure transparency and accountability of pandemic-related outlays.

Directors agreed that a gradual fiscal consolidation is needed to rebuild long-term fiscal resilience to cope with the possible fiscal cliff in FY2024. They recommended adjustment through both expenditure rationalization and domestic revenue mobilization, including a timely introduction of the value-added tax. They also stressed the importance of strengthening public financial management and public investment management to help improve access to finance and expedite the implementation of key infrastructure projects. A medium-term fiscal framework could also usefully guide budget planning.

Directors agreed on the need to continue upgrading the legal and regulatory framework for banking supervision and enhancing the authorities' supervisory capacity. In this regard, they noted that placing the FSM development bank and credit unions under the supervision of the Banking Board would help ensure effective supervision and prudent lending. Directors also underscored the importance of strengthening AML/CFT risk-based supervision to preserve U.S. dollar correspondent banking relationships.

Directors encouraged steadfast implementation of priority reforms to support private sector development. They recommended prioritizing efforts to enhance the investment climate, improve governance, strengthen coordination across states, and expand digital connectivity.

Directors agreed that strengthening the country's resilience to climate change requires speeding up adaptation and enhancing disaster preparedness. They called for prompt actions to develop an overarching National Adaptation Plan and a disaster resilience strategy.

Directors welcomed the authorities' interest in continued technical assistance in areas such as revenue administration, public financial management, banking supervision, and statistics.