September 2011
Poverty Reduction, Economic Management, Finance and Private
Sector Development, SAR
The World Bank
Maldives Economic Update
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1
Maldives Economic Update1
September2011
Overview
Tourism sector growth continues to be robust in 2011, consolidating the strong rebound in real GDP growth in 2010. Real GDP growth is estimated to be 8.3 percent in 2011, down from 9.9 percent in 2010.
Fast growing tourism receipts are supporting higher than expected government revenue outcomes. Recently introduced tax reforms, particularly the Tourism Goods and Services tax, will put medium-term fiscal sustainability on a firmer footing.
Nevertheless, fiscal consolidation remains the policy priority for the authorities. Discussions with the IMF on a program of support will resume this quarter to see if agreement can be reached on measures that ensures medium-term fiscal and debt sustainability
Domestic financing of the unsustainable fiscal deficit and rising international commodities prices continue to put pressure on the demand for foreign currency. Consequently, foreign reserves have resumed their downward trend after the boost from one-off privatization receipts.
Uncertainty related to the recent devaluation of the Rufiyaa has subsided, but it is still trading at the upper end of the band and there remains an approximately 10 percent parallel market premium. The inflationary effects of the devaluation are now being felt with consumer price inflation rising to double digits in recent months.
1 Prepared by Francis Rowe, Kirthirsri Rajatha Wijeweera and Daminda Eymard Fonseka.
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Economic Developments
Real GDP growth robust 1. Real GDP growth continues strong performance. According to the Government’s revised numbers (see Box 1) real GDP growth is estimated to have been 9.9 percent in 2010. Looking forward, growth in 2011 is expected to fall slightly to a still robust 8.3 percent, resulting from strong tourism sector growth2. Tourist arrivals have maintained the strong momentum achieved in 2010 –growing by 18.3 percent in the first seven months of 2011 (to record over 500,000 arrivals).Total bed-nights recorded 10.5 percent growth during the period, as there was a 4 percent increase in average bed capacity –primarily reflecting 3 new resorts coming into operation in 2011 (and some added capacity to existing resorts). With the growing significance of tourist arrivals from China, Maldives tourism season is experiencing fewer seasonal fluctuations as Chinese arrivals are now filling the gap left during the European summer season.3
2 Which is the largest component of GDP accounting for 35 percent of overall output under the new system. 3 That is Chinese arrivals picks up during European low season. European segment still remains the main tourist source destination accounting for 60 percent of overall arrivals.
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Figure 1. Growth in Tourism and GDP (Real, % )
Sources: Department of National Planning and MMA
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Figure 4.Seasonality profile of Maldives Tourism
Sources: Department of National Planning and MMANote: The vertical bar represents the historical variation in the monthly arrivals (as a % of full year arrivals) with the midpoint reflecting the period average
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Figure 3.Seasonality profile of Maldives Tourism
Sources: Department of National Planning and MMA Note: The vertical bar represents the historical variation in the monthly arrivals (as a % of full year arrivals) with the midpoint reflecting the period average.
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Figure 2.Seasonality profile of Maldives Tourism
Sources: Department of National Planning and MMA
Total Arrivals
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2. After a strong first quarter result, fish catch declined in 2Q11 compared to a year ago. The total fish catch contracted by 3.6 percent in the second quarter of 2011 to 20,605 MT and fell by a further 6 percent in the month of July. However, with the bumper catch recorded in the 1Q – the total catch in the first 7-months of the year still recorded a growth of 7.5 percent. As a result of these trends the earlier growth forecast for the fisheries sector (anticipated in April) has been revised down. It is now expected to contract by 8 percent in 2011. However, given its small and declining share in GDP (less than 2 percent) it is unlikely to alter 2011 growth forecasts significantly.
Box 1. New National Accounts Data Maldives rebased its national accounts series to reflect the most recent developments in the economy. The new series based on the year 2003 prices replaces the previous series of 1995 prices. The new series captures the key structural changes in the Maldivian economy. For example, new resorts opened recently are mostly targeted at the higher end of the market and as such the tourism sector was not adequately represented in the 1995 series. In both the series, the contribution of tourism to GDP remains almost same in the year 2003 and by 2010 the variation is almost 7 percentage points. The higher contribution to GDP from tourism in the 2003 results in a higher GDP growth as well.
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Real GDP Growth comparison, %, yoy
Source: Maldives Monetary Authority
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Figure 5. Fisheries Performance
Marine Exports - Left Axis Fish Catch - Right AxisSource: MMA
USD Mn MTs
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Rising international commodity prices and devaluation 3. Recent food and fuel price increases are feeding into consumer price inflation. Food and fuel products make up almost 40 percent of the CPI basket. General consumer price rises in Male reached 12.9 percent (yoy) in May4 -- in the immediate aftermath of the exchange rate adjustment and it continues to remain high at around 12.8 percent in September. Food price increases in Male rose 26.5 percent (yoy) in May (from 8 percent in April) and it continues remain high - September food prices rose 23.0 percent (yoy). In June, government raised controlled prices of staple foods in Male and in the Atolls – contributing to an one-off effect on the food price component of the CPI5. Given the large share of food and fuel prices in the overall CPI and the significant import content of most goods in Maldives, these food and fuel price increases are having a significant impact on the overall price level in Maldives. A key concern going forward is that wages rise in response to recent prices increases and high inflation becomes entrenched.
4. Exchange rate depreciation also feeding price increases. The fixed exchange rate regime was dropped in April in favor of a managed float, with a trading range of 20 percent on either side of the old fixed rate of 12.85 Rufiyaa per U.S. dollar - a range of 10.28/$ to 15.42/$. After the change, the rufiyaa quickly started trading at the upper end of the band and the latest data indicate that it remains there. With an effective depreciation of 20 percent and import content of over 60 percent of GDP, part of the recent increase in inflation is reflecting the pass through of the depreciation and its monetary accommodation. The IMF has estimated that total exchange-rate pass through into CPI at almost 80 percent, i.e. a 1 percent increase in the exchange rate would lead to an increase in consumer prices of 0.8 percent.
Figure 6. International Food and Fuel Prices
4 Compared to 5.7 percent in March and 9.4 percent in April. 5 The effect of this was much milder in the case of Male but was higher for atolls such as Seenu and Gaafu Dhaalu
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Balance of Payments pressures remain 5. Rising international commodity prices also driving import growth. The goods trade deficit continues to widen in 2011 on strong import growth (Figure 7). The trade deficit which was 40 percent of GDP in 2010 is estimated to have widened to over 60 percent of GDP in the first half of 20116. The MMA is currently in the process of revising the balance of payments estimates based on the new tourism receipts data7, which is likely to result in a downward revision of the overall current account balance. However, continued strong import growth resulting from both strong international commodity prices and an increase in resort construction is likely to keep pressure on the current account. While a rebound in foreign direct investment and private capital flows are helping to finance some of the current account deficit, public external borrowing is also expected to fill the gap. Recent loans which have been agreed in principle with China, India and Sri Lanka may be disbursed this year, although this is raising concerns of debt sustainability (see next section).
6. Foreign exchange reserves resume downward trend after one-off privatization receipts. After the one-off airport privatization payment to Government in late 2010 ($78 million) reserves resumed declining. But, this trend (Figure 7) was interrupted in March by strong tourist receipts, resort lease payments and the tourism goods and services tax collections. Reserves are still at a relatively comfortable level, but have fallen to nearly 3 months of imports. Moreover, usable reserves – excluding short-term foreign liabilities and foreign exchange deposits by banks at the Maldives Monetary Authority (MMA) - are about a third of this level. The MMA continues to ration foreign exchange to banks, while meeting part demand of some state owned enterprises. The pressure on reserves will continue as long as unsustainably high fiscal deficits persist.
6 Staff estimates. Trade deficit is estimated to have reached US$ 700Mn in the first half of 2011. 7 Which came about with the implementation of the Tourism Goods and Services Tax (TGST) from January 2011.
Figure 7. Import Growth and Foreign Exchange Reserves
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Government presses ahead with fiscal consolidation despite challenges…. 7. Revised fiscal estimates together with revised GDP numbers paint relatively better picture for government finances. The revision of the GDP estimates has had the effect of showing better fiscal outcomes especially in recent years (Figure 8). The revisions indicate that the fiscal deficit (inclusive of grants) was 12.7 percent of GDP in 2010 compared to 23.4 percent of GDP in 2009. A notable improvement to be sure, but still a distance from sustainable levels. The government’s recent efforts to improve tax collection through the introduction of new tax measures and consolidation of existing measures (see Box 2) together with much broader measures aimed at curtailing high and unsustainable levels of public expenditure will be needed to put the fiscal deficit on a sustainable path.
8. Provisional estimates of revenues collections in the 1H11 show a marked improvement. The total revenue (inclusive of grants) collection during the first half of 2011 recorded Rfy 4.0 Bn – nearly 40 percent (yoy) higher than in the corresponding period in 2010. Tax revenues increased by 69 percent to Rfy 2.3Bn – largely due to introduction of the Tourism GST (TGST), which yielded US$ 29.9 million in revenue during the 1H20118. A 25 percent increase in import duties – largely a reflection of increased imports9 witnessed during the period also contributed to increased tax revenues. However, resort lease receipts – the most significant non-tax revenue source showed a decline of 7 percent during the period (to record US$ 45.1Bn10). Notwithstanding this, total non-tax revenue (which traditionally accounts for 2/5 of total revenue) contracted only by a marginal 1 percent during the 1H11.
9. Provisional expenditure estimates show modest growth in overall expenditure. Despite the restoration of civil service salaries (to its pre-crisis levels in November 2009) total emoluments bill11 grew by just 5 percent. However, while the interest bill of the government was up 11 percent, a 4.5 percent contraction in other operational and maintenance (O&M) expenditure12 contributed to the containment of the recurrent expenditure. Consequently, overall recurrent expenditure recorded only a 4 percent growth. However, capital expenditure in 1H11 was well below budgeted levels but was still substantially higher than levels experienced in 1H10 (Rfy 496Mn in 1H11 against Rfy 177Mn 1H10). Government expenditures remain high at over 45 percent of GDP and the combination of expenditures on the wage bill and interest payments –amounts to over 70 percent of revenues (including grants). While progress has
8 The TGST was introduced w.e.f. 01 January 2011. The hitherto existed bed-tax continues in parallel. Therefore, total tourism related tax in Maldives constitutes of both the TGST and the bed-tax. This total amounted to US$ 58.0 Mn in 1H2011. 9 See discussion earlier 10 Although in RFY terms it recorded a marginal increase of 1 percent – mainly due to the depreciation of the currency during the 2Q11. 11 Which comprises of salaries, wages and allowances 12 Which comprises of expenditures such as travel, supplies, repairs & maintenance etc.
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Figure 8: Maldives Fiscal Deficit
Source: Maldives Monetary Authority (MMA)
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been made, it would be imperative that continued focus be maintained to bring expenditures to more manageable levels.
10. Expenditure control attempts may have unintended consequences. A broad based voluntary retirement scheme (VRS) for the public sector announced in mid 2011 saw over 1,500 applications being received from the roughly 35,000 strong public sector. The scheme was oversubscribed and the Government is planning to introduce a second phase of the VRS provided that they can mobilize the necessary funding13. The government also decided to abolish the posts of the applicants in a bid to permanently reduce the associated expenditure. While the move is expected to cost the government Rfy 250 Mn in 2011 (or around 0.9 percent of GDP) – there will be substantial cost savings running into the medium term. Nevertheless, because the scheme was open to any staff member this can result in adverse selection and the best persons could leave the government service, reducing capacity in the public service. Preliminary data shows that staffs applying for the VRS were concentrated in the health and education Ministries.
11. The fiscal deficit based on these provisional revenue and expenditure estimates shows marked improvement over the corresponding period in 2010. The fiscal deficit in the 1H11 recorded 4.0 percent of GDP14 compared to 9.9 percent of GDP recorded in 1H10. Considerable uncertainty underlies provisional expenditure data with likely revisions later on in the year with the full crystallization of incurred expenditure and internal audits. Indeed, like in previous mid-term expenditure estimates there is a marked difference between recorded expenditures and the expenditures inferred from ‘below the line’ financing data – the latter being somewhat higher. Notwithstanding the uncertainties associated with the expenditure and revenue data it is clear that the government has made some tangible progress in terms of improving its fiscal position in 2011 – particularly through greater revenue mobilization.15
13 The first phase of the scheme was funded from the ADB first tranche disbursement (of US$ 16Mn) under its budget support operation in 2010. 14 Based on straight line estimates of re-based GDP. 15 The Ministry of Finance and Treasury started publishing weekly expenditure and revenue estimates from the first week of September. This improves fiscal transparency and allows for a more frequent tracking of government fiscal position. Indeed, provisional results as for the first week of September show government revenue having surpassed Rfy 6.3 Bn (against a target of Rfy 8.9Bn for the whole year) while the deficit having widened to Rfy 1.3 Bn (or 8 percent of estimated GDP).
In Rfy Million Actual Budget % 2010 2011 2010 2011
Total Revenue and Grants 5,687 8,375 47 2,914 4,035 38 Total Revenue 5,677 8,232 45 2,911 3,939 35 Tax Revenue 2,893 5,117 77 1,371 2,318 69 O/W: Import duty 2,026 2,375 17 964 1,204 25 Tourism Tax 568 660 16 319 379 19 GST on Tourism - 928 - 409 Airport Service Charge 36 193 445 6 211 3,622
Non Tax Revenue 2,685 3,084 15 1,523 1,508 (1)
Capital Revenue 99 31 (69) 17 113 580
Grants 9 143 1,411 3 96 3,483
Total Expenditure excl net lending 10,203 12,371 21 4,039 4,399 9 Current Expenditure 8,087 9,713 20 3,881 4,031 4 Of which: Salaries and allowances 4,158 4,838 16 2,085 2,183 5 Interest payments 521 601 15 282 313 11
Capital expenditure 2,115 2,658 26 158 368 134
Overall balance excluding net lending (4,516) (3,996) (12) (1,125) (364) (68) Current balance (2,400) (1,338) (44) (967) 4 (100) Primary balance (3,995) (3,395) (15) (844) (52) (94)
Memorandum Item:Nominal GDP 24,428 27,292 23,362 25,860
Source: Ministry of Finance Fiscal Policy Department, Maldives Inland Revenue Authority (MIRA)Note: All data are provisional, not audited and subject to revision.
% Inc/(Dec)
Government FinancesFirst six months
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12. Domestic sources make up the majority of financing of the fiscal deficits. The budget for 2011 anticipates around ¾ of the deficit to be financed through domestic sources and the balance through foreign sources. First six month (provisional) financing data show that anticipated mix largely being met (of around 80 percent domestic financing). Much of the onus of domestic financing is being absorbed by the domestic banking sector (excluding the MMA) which has seen a considerable increase in the government securities share in total assets (GSTA) ratio from around 11.9 percent by end 2009 to 16.9 percent by March 2011. However, the increased reluctance on part of the banks to carry additional government paper in their books has been increasingly evident in recent times with progressive reduction in the GSTA since March 2011. Indeed, by September 2011 the GSTA has fallen to 14.3 percent – with the banking sector having shed approximately Rfy 500Mn worth of government securities from their books. The increased pressure of domestic financing has seen a gradual increase in the T-bill rates over time – with yield rate of the benchmark 91-day instrument having increased by 96 basis points from end 2010 to mid September 2011. A continuation of such trends is a concern given the supply constraints on foreign financing.
Box 2. Voluntary Retirement Scheme The Government of Maldives (GoM) introduced a voluntary retirement scheme for Government staff. The VRS offered the following four options for staff in government service to leave the service:
Option 1: Leave the service without any cash benefits.
Option 2: Leave the service with a lump sum payment of Rfs 150,000.
Option 3: Leave the service with a lump sum payment of Rfs 150,000, and priority for the Government implemented SME loan scheme. This was only open to staff between ages 18-50 years who meet the criterion for getting the SME loan.
Option 4: Leave the service with a lump sum payment of Rfs 200,000, and a priority for selection in Government scholarship programs. This was only open to staffs between 18 and 40 years, who meet the criterion for getting the scholarship to study.
There are two important features of the scheme. (i) Once a staff accepts the VRS package, he/she is not allowed to enter Government service (including public enterprises) for three years. (ii) Once a staff leaves Government service, his position is abolished. This is sought to be achieved by requiring the Permanent Secretary to reorganize the work of the vacated post within the functional area. Preliminary data also show that nearly 50 percent of those applying for the VRS opted for option 4 – accessing the Government scholarships program, about 30 percent applied for Option II and only 20 percent opted for Option II accessing the SME loan program.
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13. Financing fiscal deficits of these magnitudes has put the public debt dynamics at risk. On current policies public debt is expected to rise steadily to reach a present value of 306 percent of GDP by 2030. While privatization proceeds have provided some temporary financing relief, the debt path is unsustainable. As a result, Maldives’ risk of public external debt distress has increased from moderate to high since the 2009 Debt Sustainability Analysis (DSA).16 Key risks are shocks to exports and additional fiscal policy slippages. The DSA illustrates that current policies would lead to large domestic and external financing requirements that calls for additional fiscal consolidation measures in the near term. Getting the IMF program back on track will help in this regard.
16 The 2009 Joint IMF/World Bank Debt Sustainability Analysis under the Debt Sustainability Framework for Low Income Countries (IMF Country Report No. 10/28; IDA/SecM2010-0020).
Box 3: Maldives: Economic Reforms Package (ERP)
The ERP ‘package’ of the government was presented to the Majlis in mid June 2011. Prior to 2011 the country had no effective sales, personal income or corporate tax regime –with much of the core tax revenues depending on import duties and the tourism bed tax. From 2011 a new Goods and Services Tax on Tourism (TGST) came into effect (in addition to the bed-tax). The government wants to further broad base the tax system and extend the tax system to the domestic sector. The General Goods and Services Tax (GGST): The GGST legislation advocated a GST levy of 5 percent to be levied on all supplies of goods and services carried out in the country with the exception of supplies related to tourism –which is covered under the Tourism Sector GST (TGST). The bill was passed by the house on 29 August 2011, and the legislature was ratified by the President on September 2nd. The tax will become effective from 1 October 2011. However, when the bill was passed by the house the applicable rate was revised down to 3.5 percent for 2011. This rate will be revised upwards to 6 percent with effect from 01 January 2012. Although the GGST will apply to a broad range of goods and services supplies, the supply of several goods and services are exempted –including supplies of electricity, water, telecommunication services and health services. In addition, several essential items and exported items have been zero rated. The GST legislation ratified by the Majlis also had provisions to raise the hitherto applicable TGST rate of 3.5 percent to 6 percent in 2012 and 8 percent in 2013. The Corporate Profit Tax Bill attempts to simplify the current Business Profit Tax Law by narrowing its scope to corporate bodies only, namely companies, partnerships and corporate bodies. Tax-free threshold remains at MVR 500,000 per annum along with the tax rate of 15% and withholding tax of 10%. The Bill also proposes to abolish the Bank Profit Tax Act (Law Number 9/85) and to tax banks under the new Corporate Profit Tax regime. The basis of taxation for banks, however, remains at 25% of taxable profits and without a tax-free threshold. The Personal Income Tax Bill proposes to establish, for the first time, an income tax system in the country covering all wage earners – both foreign and local. Under the proposed legislature, all wage earners earning above Rfy 30,000 will be subject to the tax on a progressive scale – ranging from 3 percent to a top rate of 15 percent:
Income range PIT Rate Rfy 30-60,000 per month 3% Rfy 60-100,000 per month 6% Rfy 100-150,000 per month 9% >Rfy 150,000 per month 15%
The tax will also have PAYE features warranting employers to withhold the relevant percentage of tax on monthly income in excess of MVR 30,000. The proposed amendments to the Tax Administration Act incorporated the administrative procedures needed to enforce the new taxes. It also consolidated several tax administrative procedures in relation to the BPT and the TGST in order to see better streamlining of procedures relating to these taxes.
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Outlook 14. We identify three main risks to the outlook. The first is a deepening of the growth slowdown in Europe, which will negatively impact tourist arrivals and hence growth. The second is continued rising international commodity prices, which as noted above will ultimately deepen the pressure on foreign exchange reserves. Although, if the debt crisis in Europe translate into a generalized global growth slowdown then pressure on international commodity prices could be expected to subside. While this would help ease balance of payments pressures, fiscal revenues would be hurt by the decline in arrivals. Lastly, failure to present a 2012 budget that puts the public debt-to-GDP ratio on a downward trajectory would delay the agreement on an IMF program and mean that deficit financing options would become much more difficult going forward. More on the fiscal outlook is below.
15. Outlook on the fiscal front remains mixed. On June 20, 2011 the government presented four bills –collectively referred to as the ‘economic reforms package’ (ERP) to the Majlis. The ERP comprised of: (a) a (general) Goods and Services tax (GST) bill (b) a Corporate Profits Tax (CPT) bill; (c) a Personal Income Tax (PTB) Bill and (d) an amendment bill to the Tax Administration Act. Of the measures the GST was passed by the house in end August and was ratified into law in early September. The tax will come into effect in October. The GST Act also had provisions to raise the hitherto applicable TGST rate to 6 percent in 2012 and thereafter to 8 percent in 201317. The other measures were still at (Majlis) committee level deliberations at the time Majlis went into recess in end August. It is expected that the final voting on the measures will take place in November. At the same time the government has also contemplated pruning customs duties on a wide array of items18 that could compromise revenue from this significant source. Discussions on getting the IMF program back on track based on these developments are scheduled to take place later in the year.
World Bank Assistance to Maldives in FY11
16. World Bank staff completed a progress report on implementation of the Bank’s Country Assistance Strategy (CAS) in May 2010. It aims to better support the government’s implementation of the Strategic Action Plan and other key CAS objectives. The current portfolio is comprised of 3 IDA operations (environmental management, mobile phone banking, and pension and social protection) with a net commitment value of $36.7 million. A development policy loan was also approved in FY11. A Country Assistance Strategy for FY13-16 will be prepared this fiscal year. A mobile-phone banking project, requiring US$7.7 million, was approved in April 2008. The
project is designed to improve access to financial services by creating a single-currency payment system for mobile telephone-based accounts, enabling subscribers to transfer funds to and from bank accounts, and to and from telephone-based accounts;
An environmental management project, requiring US$13.2 million, was approved in May 2008.
The main aim is to provide the Maldives with the capacity to manage environmental risks and threats to fragile coral reefs and marine habitats resulting from tourism development, increased solid-waste
17 The rate was 3.5 percent in 2011 – the first year of implementation. 18 Provisions also include raising duty on few other items – notably tobacco and plastic material which will have an offsetting effect.
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disposal, fisheries and global climate change. The project has two development objectives, to: (i) establish a solid-waste management system for inhabitants on targeted islands, reducing the risks of contamination associated with accumulated wastes and sea dumping, and; (ii) train people for environmental management;
A pension project, requiring US$3.8 million, was approved in May 2009 and $12m in additional
financing was approved in June 2011. The primary objective is to support the introduction of a new pension system comprising two elements – one contributory and the other non-contributory – in order to provide income protection for aged citizens. A secondary objective involves rationalizing the public administration by introducing a sustainable retirement scheme for civil servants. The project will seek to protect retirees from a decline in consumption, and lay the institutional and administrative groundwork for other social protection programs, and;
An economic stabilization and recovery credit was approved on March 4, 2010. The development policy credit aims to support the government’s program to stabilize the economy, and puts in place some of the key elements needed for a sound recovery. There are three main areas of the government’s reform plan that this proposed operation will support: (i) public financial management, specifically budget preparation, implementation and monitoring; (ii) public enterprise reform, specifically to help ensure that the government-planned PPPs appropriately minimize future fiscal risks to the government, and; (iii) social protection, specifically to support the government’s effort to lay the foundations for harmonized national social protection system.
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