The Maldives has suffered “significant policy slippages” that have undermined the country’s capacity to address its crippling budget deficit in 2011 and beyond, the International Monetary Fund (IMF) has warned, in a statement concluding its Article IV consultation with the Maldives.
“On the expenditure side, there have been no net fiscal savings from public employment restructuring, public sector wages will be restored to their September 2009 levels earlier than expected, and the new Decentralisation and Disability Bills will lead to considerable spending increases,” the IMF stated. “Also, the Business Profit Tax will come on stream eighteen months later than planned.”
The IMF warned that the Maldives economy was presently unsustainable, on the back of “expansionary fiscal policies” from 2004 which left the country especially vulnerable to the decline in tourism during the 2008-2009 recession.
The country’s financial deficit exploded on the back of a 400 percent increase in the government’s wage bill between 2004 and 2009, with tremendous growth between 2007 and 2009. On paper, the government increased average salaries from Rf3000 to Rf11,000 and boosted the size of the civil service from 24,000 to 32,000 people – 11 percent of the total population of the country – doubling government spending from 35 percent of GDP to 60 percent from 2004 to 2006.
While preliminary figures had pegged the 2010 fiscal deficit at 17.75 percent, “financing information points to a deficit of around 20-21 percent of GDP”, down from 29 percent in 2009, the IMF reported.
The IMF said that while it recognised “the difficult political situation facing the authorities”, “decisive and comprehensive adjustment measures” were required to stabilise the economy, allow sustainable growth and reduce poverty. In particular, it raised concern about the “lack of significant progress in public employment restructuring.”
“Efforts to strengthen the financial sector and improve the business climate will also be critical,” the IMF said, noting that private sector credit had all but stalled. However it generously conceded that the pace of adjustment “should take into account political constraints.”
The IMF’s Mission Chief to the Maldives, Rodrigo Cubero, told Minivan News that while the government had introduced the core components of a modern tax regime that would begin generating revenue from this year, these achievements were offset by new spending on legislative reforms such as the decentralisation act.
“We see bringing the fiscal deficit down as the key macroeconomic priority for the Maldives,” Cubero said. “A large fiscal deficit pushes up interest rates, thereby undermining private investment and growth, and also drives up imports, putting pressure on the exchange rate and inflation, all of which hurts the Maldivian people, particularly the poor.”
“Further efforts are still needed to reduce the fiscal deficit. Those efforts should comprise further tax reforms as well as measures to reduce expenditure and to improve the channelling of social expenditures to the needy.”
He would not be drawn into the politics of the Maldives’ economic situation, “but what we can say with confidence is that broad political support will clearly be needed both to design an economic programme and to carry it out as planned. That is why we also support as broad a spectrum of consultations with different stakeholders as possible.”
The Maldives graduated in January 2011 from the UN’s ‘Less Developed Country’ designation to ‘Middle Income’, a move which reduces its access to certain concessional credit and donor aid.
Cubero said that as far as the IMF was concerned, “the Maldives remains eligible to the IMF’s concessional financing under the Poverty Reduction and Growth Trust (PRGT). The IMF follows its own rules and procedures to determine PRGT eligibility; the criteria include income per capita, market access, and short-term vulnerabilities.”
The Maldives had, he said, “made significant economic progress in recent decades, allowing it to reach middle-income status. However, given the large public debt and still very large fiscal deficit, it is very important that the financing terms for the Maldives’ public borrowing remain as favourable as possible. While reducing the fiscal deficit is imperative to maintain debt sustainability, favourable financing conditions would also help keep debt manageable.”
In its report, the IMF was broadly confident that the Maldives could stabilise its economy in the medium term, due to the tight monetary policy of the Maldives Monetary Authority (MMA) in mopping up excess liquidity, as well as the passing of the Business Profit Tax and a Tourism Goods and Service Tax.
The economy had rebounded strongly after shrinking 2.25 percent in 2009, and GDP growth for 2010 was an estimated 4.75 percent, the IMF said, with an expected inflation rate of five percent in 2010.
As for the ongoing dollar shortage, while the IMF did not actively advocate a revision of the pegged exchange rate, it did call for “continued discussions between the authorities and the staff on this issue while being mindful of the risks involved and the impact on the poor.”
“The MMA continues to ration the supply of foreign exchange to banks, while fully meeting the demand from the central government and some state-owned enterprises,” the IMF stated. “Dollar shortages persist, and the parallel market premium has increased somewhat.”
In November 2010 the IMF delayed a disbursement under the second review of its program with the Maldives, ahead of the 2011 budget.
The delay, Cubero explained at the time, was due to the “fiscal slippages” caused by insufficient progress towards reducing the wage bill and passing tax legislation – most significantly, the Business Profit Tax.