physical viability of numerous islands, particularly in RMI. Finally, governments NORTH PACIFIC Key conditions and need to implement structural reforms to ensure sustainable economic recovery that challenges ISLANDS supports livelihood of the bottom 40 per- cent of households. However, the lack of More than 95 percent of the population in recent household data makes it challeng- Palau is fully vaccinated from COVID-19, ing to monitor development progress and Table 1 2021 and almost 70 percent of the population impacts of shocks while also limits the po- Population, million has received a third booster dose. The vac- tential for evidence-based policy. Federated States of Micronesia 0.12 cination rate is relatively lower in FSM and Republic of the Marshall Islands 0.06 RMI. Palau’s border is now open for fully Palau 0.02 vaccinated international travelers. Howev- North Pacific GDP, US$, billion 0.19 er, tourist arrivals are yet to recover with Recent developments Federated States of Micronesia 0.40 monthly arrival per end-January was only Republic of the Marshall Islands 0.24 6% of pre-COVID number. In the short The economic impact of the pandemic Palau 0.22 term, the key challenges facing the North drove FSM and RMI into the second year North Pacific 0.86 Pacific are: (1) The vaccine rollout and of consecutive recession in FY21. Output is GDP per capita, current US$ management of the pandemic, to pave the estimated to have contracted by a further Federated States of Micronesia 3475 way for relaxed border restrictions and 3.2 percent in FSM and 2.5 percent in RMI Republic of the Marshall Islands 4337 gradual recovery of international arrivals. in FY21. Ongoing strict border closures Palau 12405 (2) To support a sustainable and inclusive and related trade disruptions have cur- North Pacific 4433 economic recovery while managing fiscal tailed construction activity, transport and Sources: WDI, World Bank staff estimates. risks (particularly in Palau). domestic consumption. Large parts of FSM Over the medium term, the key challenge and RMI government revenues have been is the scheduled expiry of Compact-related relatively protected from the downturn in COVID-19 has led to recessions in the Fed- grants and programs in 2023-2024. This domestic activity, particularly donor erated States of Micronesia (FSM), Repub- poses a key structural risk to long-term fis- grants and fishing revenues. Grants, com- lic of the Marshall Islands (RMI) and Palau. cal sustainability, considering the limited bined with substantial fiscal buffers in space for additional debt. This is exacer- FSM, provided fiscal space for stimulus, A gradual recovery is projected from FY22. bated by the fact that the projected annual which was rolled out during FY20 and In the short term, moderate fiscal surpluses distributions from the nations’ Compact- FY21. FSM and RMI registered fiscal sur- are projected for FSM and RMI, while related trust funds are not sufficient to ful- pluses of 1.3 percent and 2.8 percent of Palau’s fiscal deficit will remain sizable. ly offset the expiring fiscal transfers. Given GDP in FY21, respectively. Medium-term fiscal risks are substantial, this risk, reform-based fiscal adjustments, In Palau, the pandemic has severely impact- such as domestic revenue mobilization ed the economy. The tourism industry and primarily due to the scheduled expiry of US and expenditure rationalization, are criti- its related business activities (around 40 Compact-related fiscal transfers, highlight- cal to cover fiscal gaps. Natural disasters percent of GDP) have been curtailed and ing the importance of structural reforms. and climate change also pose a threat to trade flows are severely disrupted. GDP is livelihoods. Sea level rise threatens the estimated to have contracted further by 17.1 FIGURE 1 North Pacific Islands / Overall fiscal balance FIGURE 2 North Pacific Islands / Formal sector (share of GDP) employment (Index, 2017=100) Percent of GDP Index 30 110 Palau 25 Republic of the Marshall Islands 20 105 Federated States of Micronesia 15 100 10 5 95 0 Palau -5 90 -10 Republic of the Marshall Islands -15 85 -20 Federated States of Micronesia -25 80 FY17 FY18 FY19 FY20(e) FY21(e) FY22(f) FY23(f) FY24(f) FY17 FY18 FY19 FY20(e) FY21(e) FY22(f) Sources: National sources via EconMap and World Bank projections. Sources: National sources via EconMap and World Bank projections. MPO 1 Apr 22 percent in FY21, after more than 90 per- arrival. The Palauan economy is project- percent of GDP in FY20 to 2.2 percent of cent drop in tourist arrivals. The fiscal ed to grow by 7.2 percent, on the back of GDP by FY24. Palau is projected to have deficit widened to over 18 percent in gradual recovery of the tourist arrivals to a fiscal deficit of 2.6 percent of GDP in 2021 driven by a decline in non-grant around one-third of the pre-crisis level. FY23 before return to a balance in FY24 revenues and a rise in health spending However, strong resurgence of the virus due to increase in tourism receipt and full and relief measures for firms and house- globally or local outbreaks could neces- implementation of tax reform bill. holds. This deficit has been financed by sitate a significant tightening of contain- Poverty in the North Pacific is expected external borrowing, which is estimated to ment measures and delays in reopening, to have risen relative to pre-crisis levels. have raised general government debt to which can derail the recovery and damp- The sharp economic contraction in FY20 around 85 percent of GDP from around en growth prospects. Fiscal surpluses of and FY21 led to formal-sector job losses 39 percent in FY19. 2.8 percent and 2.5 percent of GDP are and lower demand for goods in the infor- projected in FSM and RMI, as tax rev- mal economy. The rebound in formal sec- enues recover in line with economic ac- tor jobs in FY22 is expected to be slow. tivity. Another large deficit of 12.1 per- For Palau, the severe impacts on econom- Outlook cent is projected in Palau, as non-grant ic activity and jobs have led to increased revenues remain around 7 percent below vulnerability for substantial number of The timing and shape of the economic pre-crisis levels. households that predominantly work in recovery in the North Pacific depends GDP is not expected to recover to pre- the tourism sector. For FSM and RMI, on when international arrivals can fully crisis levels until FY23 in RMI and FY24 many households rely on annual remit- resume and the fallout of the Russia- in FSM. For Palau, GDP is projected to tance inflows (around 6 percent and 13 Ukraine war. For FSM and RMI, easing remain on a relatively lower trajectory, percent of GDP, respectively) that border restrictions will facilitate entry compared to pre-pandemic level, until dropped in FY21 and is estimated to re- of foreign workers, merchandise imports tourist arrivals fully recover in FY24. For main depressed in FY22 due to the im- and business travels, while for Palau, in- all three countries, the negotiation with pacts of the pandemic on US labor market crease in international arrivals will boost the U.S on Compact-related fiscal trans- conditions. There are only recent poverty the tourism recovery. Conditional on the fers is ongoing, and the terms and timing estimates for RMI, in which poverty is easing of restrictive arrivals by mid-2022 remain uncertain. Fiscal risks are tilted predicted to fall slightly in FY22, if eco- and a recovery in global economy, a to the downside with potential reduction nomic growth materializes. In FSM, the rebound is projected in FY22. The in grant revenues. Under current policies, country with the highest poverty rate in economies of the FSM and RMI are pro- the FSM will face a fiscal cliff in FY24 and the North Pacific, poverty reduction is jected to grow by 0.4 percent and 3.0 per- projected fiscal deficit of 4-5 percent of likely to be slower, given the huge share cent, due to the expected pick-up in con- GDP from FY24 onwards. In RMI, the fis- of informal sector and lower rebound of struction, tourists, and foreign workers cal surplus is projected to decline from 5 economic growth in FY22. TABLE 2 North Pacific Islands / Macro poverty outlook indicators (annual percent change unless indicated otherwise) 2019 2020e 2021e 2022f 2023f 2024f Real GDP growth, at constant market prices Federated States of Micronesia 1.2 -1.8 -3.2 0.4 3.2 1.9 Republic of the Marshall Islands 6.6 -2.2 -2.5 3.0 2.4 2.6 Palau -1.9 -9.7 -17.1 7.2 16.2 4.5 a,b Upper middle-income poverty rate ($5.5 in 2011 PPP) Republic of the Marshall Islands 22.5 24.0 26.7 24.5 24.1 23.0 Sources: ECONMAP, IMF, and Worldbank. e = estimate; f = forecast. Note: Values for each country correspond to their fiscal years ending September 30. (a) Calculations based on EAPPOV harmonization, using 2019-HIES. (b) Projection using neutral distribution (2019) with pass-through = 1 (High) based on GDP per capita in constant LCU. MPO 2 Apr 22